Financial markets have turned volatile as two forces collide: bottlenecks in artificial intelligence infrastructure investment and fears of prolonged high interest rates after the yield on 10-year U.S. Treasuries broke above 5%. Investors still building wealth can ride out such swings through steady contributions. Those who have just retired face a different problem. In the withdrawal phase, when living expenses must come out of the portfolio every month, they may be forced to sell assets and lock in losses. Running into a market correction early in retirement is known as sequence of returns risk.
A simple thought experiment shows how this works. Suppose an asset gains 20%, 15% and 10% in its first three years, then falls 10%, 15% and 20% over the next three. If no money is taken out, the final value after six years is identical even if the order is reversed. Withdraw living expenses at the start of each year, however, and the outcome changes. The portfolio that hits the downturn first ends up with roughly 20% less than the one that enjoys the rally first. Average returns may be the same, but the order in which they arrive decides how retirement turns out.
In simulations by the Mirae Asset Investment and Pension Center aimed at preserving assets for 30 years or more after retirement, the primary safeguard proved to be appropriate asset allocation. Holding the withdrawal method constant and varying only the allocation, the probability that retirement assets would not be depleted over 30 years ranged from as low as 60% to as high as 99.7%. Relying solely on bank deposits and savings accounts was not an adequate answer, because inflation erodes real purchasing power.
The next consideration is the withdrawal rule that sets how much to take out each year. The best-known is Bengen's 4% rule, under which retirees withdraw 4% of assets in the first year and then raise the amount each year in line with inflation. Along paths where returns in the first five years of retirement fell in the bottom 20%, however, the probability of not lasting 30 years reached 43.4%. Another option is the Guyton rule, which skips the following year's increase in living expenses whenever the prior year's return was negative. In that case, the probability that retirement assets would fail to last 30 years or more fell to 19.7%. Even so, the improvement in the failure rate did not match what asset allocation achieved. Withdrawal rules amount to a secondary safeguard.
The foundation of a successful retirement lies in appropriate asset allocation. However refined a withdrawal rule may be, it operates only within the range that asset allocation has already set. Building the frame with a globally diversified portfolio comes first; deciding how to adjust pension withdrawals in bad years comes next. Setting allocation principles before retirement, and fixing in advance the spending adjustments to follow when markets shake — that is the most practical way to protect a retirement that may last more than 30 years.