Retirement Income Is Path Dependent

If you need retirement income from investments, you will soon discover that within the investment markets, not every year is like every other. The long-run rate of return is not meaningful if the shorter term costs all your money. The rule is “If the short term doesn’t work, the long run doesn’t matter.”

The average rate of return is of no help.

While accumulating money, the average tends to work in your favour. Over the years, a bad year is offset by a great year or two somewhere else. Dollar-cost averaging tends to work as you deposit, which is the key to understanding the withdrawal problem.

Deposits provide you with a dollar-cost averaging advantage, but when you are withdrawing, DCA harms you. When accumulating, your deposit buys more of the underlying securities. If markets are down, you must remove more capital to make your target income need. If markets are down in the early part of your retirement, you may not have your income last as long as you hoped.

An easy way to see it.

To supplement your pensions, you have saved $500,000 to support your additional spending needs. For this example, you want $30,000 per year plus 2% inflation. You use stocks as your investments and notice that the average return is around 8% after fees over long periods. You might feel safe relying on the idea that markets are up and markets are down, but overall they average more than you are taking out.

Except, your rate of return might follow two paths:

  • The return on the money from 2001 to 2019 on the S&P TSX index in the order it happened, and
  • The same capital, the same withdrawals, the same average rate of return, and the same index but in the order of 2019 to 2000.

Everything is the same except the order of returns earned.

At the end of 2019, 2001 to 2019 ordering leaves $239,000 in the fund, while 2019 to 2001 ordering leaves $447,000.

Thanks to Canada Life for the example.

Some things to think about

The average rate of return is about the investment return, and when there are withdrawals, it is not about how much remains in the portfolio.

Portfolios can be built to provide highly predictable results if you want to be sure. Long bonds or life annuities might comfort you about the anticipated earnings, but the yield may not be high enough to give you the income you want. Most people prefer spendable money to average yield.

Most people don’t buy long bonds. If they use bank Term Deposits, market volatility risk is still present. You can’t know the rate at which you can reinvest.

When withdrawing money from a portfolio, the expected average rate of return hides the risk of exhausting your capital. When examining your plan, test it under volatility conditions.

You could adjust your cost of living in the down years and minimize the harm. Faced with the situation, many people can do that. Not all, though. Be sure your spending plan has some flexibility.

Consider using options to collar the potential losses. Give up some upside for better protection of the downside. You’ll likely need a manager.

Assess inflation too. If inflation moves your spending from $30,000 plus 2% inflation to $30,000 plus 5% inflation, the problem becomes dramatically worse. 2% inflation takes about 35 years to double the withdrawal, while 6% inflation will double it in 12 years.

Life is about trade-offs. You may need to use several of the techniques above to be comfortable. Putting retirement spending into a formula with a fixed amount of money is not a strong decision. In my view, withdrawing 6% of the portfolio annually plus inflation was not well conceived. When you show clients the problem, they may agree to something lower. 4% of the portfolio is optimistic if it is to last more than 30 years. Be sure to know what the money will be used for. If it is vacations, it may be possible to amend those to something less costly. If it is for rent, there is less flexibility, and greater care is necessary

Understand how diversifying indexes is helpful. Pay attention to potential currency change too.

The bit to take away

Never trust an average to meaningfully apply to your particular situation.


I build strategic, fact-based estate and income plans. The plans identify alternate ways to achieve spending and estate distribution goals. In the past, I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning. I have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, and Banks – from CIBC to the Federal Business Development Bank.

Be in touch at 705-927-4770 or by email at don.shaughnessy@gmail.com.

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