One of the most common mistakes many retirees make is reverse cost averaging of their retirement savings withdrawals. This is withdrawing the same consistent amounts on a monthly or annul basis through market ups and downs.
Very important to understand the difference between dollar cost averaging that is good for saving money, and reverse dollar cost averaging when it comes to taking withdrawals after retirement that can hurt your net worth over time if not clearly understood.
Most people saving for retirement are familiar with the concept of dollar cost averaging. This is a proven successful strategy of making regular consistent deposits into your retirement savings over time through market ups and downs.
Market ups and downs cannot be anticipated. Saving a consistent amount over time on average will be a winning strategy because historically the market has always come back stronger.
Reversing Mindset Going from Saving to Taking Withdrawals
People spend their entire working lives with the mindset of saving and investing for retirement when they have a regular paycheck. However, once the steady paycheck stops coming in it requires a complete reversal of thinking about what has been a winning strategy with dollar cost averaging for saving money, to understanding the dangers with this approach for taking saving withdrawals that can derail your best retirement planning!
Selling low locks in losses. If you take a withdrawal when the market is down remember, any asset is ultimately only worth the price at which it is finally sold. If you sell at a low price you lose forever the gains the asset could have made if it had been allowed to recover. More shares need to be sold to match the expected dollar withdrawal amount.
Not understanding this basic principle accelerates the erosion of your portfolio over time. Depending upon how severe a market downturn is, converting the same dollar amounts of stocks each year for retirement savings withdrawals can dramatically reduce your investment returns and the money you don’t know how long you will have to make last.
By eroding your base of capital for future growth, it accelerates the effects of inflation. It can be emotionally very disturbing for retirees to watch their saving erode fueling their anxiety of outliving their savings the risk of reverse dollar averaging.
How to Protect Against Reverse Dollar Cost Averaging
Rigid withdrawal strategies that are based upon a fixed dollar amounts are the problem that don’t take into account the ups and downs of the market. For example, consistently withdrawing $50,000 each year.
The solution is taking a flexible percentage-based approach to withdrawals. For example, taking 4% of the principle a year, adjusting regularly for market conditions.
Another way to protect against reverse dollar cost averaging is the “Guardrails” method. This involves only taking withdrawals when the portfolio crosses certain thresholds. This approach strikes a balance between spending and sustainability.
Avoid Selling Stocks During Down Markets
Another approach is to avoid selling stocks during retirement in a bear market. Sell more stocks than you will immediately need in a bull market. This requires being able to hold stocks for a longer period of time to recover and have other funds to be able to draw upon in that time frame.
Historically, the stock market experiences a correction of 10% almost every year. A bear market, which is a correction of 20% or more has occurred about every 4-6 years.
Following these corrections/bear markets, the stock market has always recovered and gone even higher than the previous high point. So, we want to make sure that if there should be a market crash there is enough time for your investments to recover and grow.
This is complicated and should be done with the help of a Certified Financial Planner. If mishandled, it can easily hurt rather than help your retirement savings.
“NextPhase™” Segmented Funds Approach
By far the most effective way of preventing reverse dollar cost averaging is setting up your portfolio using the NextPhase™ approach with a Florida financial planner. The NextPhase™ approach is to divide you money up into segments based upon the time line of your life in which you will be needing the funds.
In keeping with the goal of safety, the money that you will need in the near future will be invested more conservatively than the money you will need ten or twenty years out.
The money you will need for at least the next five years will not be exposed to the stock market at all. And as time goes on, money continues to be shifted from market based investments like stock to non-market-based investments as you get closer to using that money.
Money needed for the next five years can look very different from an investment perspective than the money that will be needed fifteen years out. The money fifteen years out obviously is going to be invested for a fifteen-year period. So, it certainly is going to be invested more aggressively because if the market corrects today, you have fifteen years for your investment to recover.
This time-segmented, inflation-adjusted strategy can help give you confidence that you will not outlive your retirement income.
Find out more about the NextPhase™ Retirement Income Solution
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Steven Fenyves, CFP®, CFS, founded Valued Wealth Management in 2005. He and his team of professionals help successful professionals prepare for retirement on their terms and stay comfortably retired. They also design corporate retirement plans to serve businesses and their employees.
Steven graduated from Hofstra University with a BA in Accounting. He holds the Certified Financial Planner™ (CFP®) designation and he is also a Certified Fund Specialist (CFS).
Steven is a member of the Greater Boca Raton Estate Planning Council.
For more information or to schedule an appointment at our Boca Raton, Florida office please contact:
steven@valuedwealth.com
(561) 392-4646