Do you think you’re a long-term investor who should buy-and-hold through a bad market? If you are retired and drawing money from your investments, I think that’s a very dangerous idea. In fact, if you had retired 15 years ago and then followed a buy-and-hold strategy, you would now be out of money.
Let’s say you retired in January of 2000 with $1 million. Where would you be today if you took out the frequently prescribed 4% for your cost of living (adjusted for inflation) and rode the market down through the Y2K and the 2008 bears? Let’s look at the numbers.
You began your retired life with $1 million. Each year you took out 4%, or $40,000. You also had to take out 3% more each year to keep up with inflation: In Year 1, the amount you withdrew was $40,000; in Year 2, it was $41,200; in Year 3, $42,436, etc.
So in 2000, your first year of retirement, you took out $40,000, but, oops, the market went down 10%, and you lost $100,000. You were left with $860,000. Then the market dropped 13% in 2001, gobbling almost $112,000 of your investments, plus you took out $41,200* to live on. Your investments fell to $700,000.
Then 2002 came along and the market plunged 23%. You were down to $500,000. You lost half your nest egg in three years. Luckily, in 2003, the market went up 26%, and your investments grew by $131,000, for a total of $600,000.
Let’s fast forward from there to 2008, when the market plummeted 40%. You would have lost $200,000, plus you took out $50,000 for living expenses. Guess how much money you would’ve had left. $290,000.
That’s right, in eight years, your investments would have gone from a million dollars down to less than $300,000. Not only that, but that $50,000 you withdrew for cost of living was no longer 4% of your investments, but closer to 19%. In order to support your lifestyle, you would’ve had to make 19% every year for the rest of your life. If you didn’t, you would be flat broke by 2013.
Buy-and-hold is great if you’re 20 years old and can play through 30 years of market fluctuation, but if you’re retired and taking money out while your investments are going down, you are eating your seed corn. A great growth season doesn’t make a difference if you have nothing left to plant.
To me, it’s simple. If you are retired, you have to protect the money that generates the returns. I believe you can’t buy-hold if you are a retired investor. You have to defend your investments with a buy, hold and sell strategy.
* From here on I’ll round to the nearest thousand.