Volatility Eats into Retirees' Portfolios, Even if the Rate Is the Same

February 11, 2009

If you’re not withdrawing money from your portfolio, volatility doesn’t matter if the return is the same in the end. But if you’re a retiree taking money out, it can make a big difference.

Why isn’t 7% the same as 7%?

If you’re not withdrawing money from your portfolio, volatility doesn’t matter if the return is the same in the end. But if you’re a retiree taking money out, it can make a big difference.

With a $1 million portfolio, the difference could be up to $337,100 over 20 years.

Consider four hypothetical $1 million portfolios modeled by Financial Advantage. All produce a 7% annual average return, and they’ll be spent down to practically zero after 20 years. Yearly withdrawals start out in the 5.2% to 6.6% range, with the dollar amounts gradually increasing because of inflation.

The steadiest portfolio produces annual returns that range from -1% to 10%, while the second-steadiest portfolio’s returns range from -10% to 12%. The portfolio with the second-highest volatility has returns that range from -7% to 21%, while the most volatile portfolio careens from -25% to 20% annually.

Over 20 years, the total amounts withdrawn from the four portfolios stack up like this:

$1,774,520 (least volatile)

$1,640,436

$1,556,869

$1,401,424 (most volatile)

Different assumptions would produce different numbers, but the lesson is clear: Volatility punishes retirees. When you must withdraw funds during a big down year—especially early on—your portfolio takes a disproportionate hit. CDs and Treasuries aren’t the answer, because they won’t beat inflation.

Bonds, High-Yield Stocks Lower Volatility

Retirees can both lower volatility and get good rates of return with an actively managed basket of assets, including high-quality corporate bonds, agency bonds, high-yield stocks like utilities Duke and Spectra (6.5% yields), Canadian Royalty trusts such as Enerplus, and gold.

While you need to get growth and income, when you’re retired, protecting what you have is the top priority. It’s a different game than it is for someone who’s working and saving.

Lyn Dippel is an advisor with Financial Advantage, which provides personal financial planning and investment-management services to retirees and aspiring retirees on a fee-only basis. Wealth Manager magazine has named Financial Advantage as one of the top 200 independent financial advisory firms in the country. Web: www.financialadvantageinc.com