Too Much Risk Can Ruin Your Retirement

By Chris Palabe, CFS®, AIF®

Retirement marks a significant turning point in life, offering the chance to embrace your newfound freedom while pursuing long-held dreams. However, if you’re going to create a fulfilling and satisfying retirement, it’s crucial to establish a robust plan so you have a source of ongoing income in this new phase of life. How will you sustain yourself financially for decades to come?

Unlike saving for retirement during your working years, distributing your retirement savings requires a fresh perspective and careful consideration—both technically and emotionally. Whether you’re starting the retirement planning process or already enjoying your golden years, this guide offers advice and practical strategies for mitigating retirement risk to help you navigate this exhilarating stage of life with confidence and ease.

Safe Withdrawal Rate Is More Important Than Rate of Return

When it comes to retirement planning, many people focus solely on the rate of return they can expect from their investments. However, what is often overlooked is the amount you will be withdrawing from your retirement fund each year. This is where the concept of a safe withdrawal rate comes in. How much can you withdraw from your accounts without risking running out of money later on in life? 

The most commonly cited safe withdrawal rate is the 4% rule, which is a theory about how much money you can safely withdraw from your retirement accounts each year without running out of money. The 4% rule became widely publicized after Bill Bengen’s research in 1994, (1) which showed that withdrawing up to 4% of retirement assets, and then adjusting annually for inflation, could sustain the typical 30-year retirement going all the way back to 1926. 

On the surface, it may seem like withdrawing 4% is definitely the way to go. After all, the data goes back nearly 100 years! But it is important to keep in mind that the safe withdrawal rate is just a guideline and should be adjusted according to your personal financial situation and goals. Nevertheless, when you reach retirement and start taking an income from your portfolio, the amount you withdraw from your retirement fund each year should be more important than the rate of return you receive. 

Diversification Is Key

Diversification is a critical aspect of a successful retirement strategy. When you’re working, it’s common to have a fairly aggressive investment approach and a portfolio containing a high allocation in stocks. Most people during this time have a goal of accumulating assets and seeking growth. But when you reach retirement, you shouldn’t keep the same investments you’ve had the last few decades. As we saw during the tech bubble in the early 2000s, the Great Recession in 2007-2009, and the first few months of COVID-19 in 2020, the stock market can drop 30% to 50%, and sometimes it can do that quickly. 

What would your income in retirement look like if you were dependent on a portfolio that was highly allocated in stocks? 

Situations like those are why we want to have diversification in your investment portfolio. We want to have other assets, besides stocks, that don’t fall nearly as much in a downturn, so that if you need income, we can generate it from those assets while we wait for your stock portfolio to recover.

In addition, this diversification can level out the highs and lows of investment, hopefully giving you more comfort and confidence in your investment and income strategy.

The Emotional Element of Retirement Withdrawals vs. Contributions While Working

Accumulating assets for retirement is often driven by a sense of hope and optimism that you’re working toward a great goal and contributing to it every two weeks. But drawing down your accounts in retirement often brings a completely different emotional experience with heightened anxiety and a fear of loss. In addition, any potential losses feel like a bigger deal, since this may be the only pot of money you have, and you don’t want to be forced to go back to work because it’s fallen too much. 

To mitigate this emotional stress, it’s not only important to stay within a safe withdrawal rate range (which can be easier said than done); it’s also critical to have the support of a good financial advisor who can provide the technical guidance you need, as well as emotional support and encouragement to stick with the plan. In collaboration with your financial advisor, you can make informed decisions during periods of market turbulence that will help you stay focused on your financial goals.

Assess the Right Amount of Risk

Balancing retirement distributions involves understanding both the technical and emotional components of a withdrawal strategy. If you’re uncertain about the right level of risk for your portfolio and how to create a reliable income stream to last a lifetime, our team at Palabe Wealth is here to provide support. Schedule a 15-minute introductory phone call or call us at 847-249-6600 to learn how we can help with risk management and distribution strategies. 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

This material was prepared for Palabe Wealth Inc.’s use.

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(1) Bill Bengen: How to Monitor and Adjust Withdrawal Plans, VettaFi, October 9th, 2023