Don’t Drop the Baton in Retirement: Managing the “Handoff” From Saving to Spending

A smooth exchange in a relay race is a thing of beauty – the baton passing from hand to hand, runner to runner, in liquid motion. Such a “changeover” represents an enviable model for managing the transition from working and saving (accumulation) to retirement and spending (decumulation). Recent market volatility and rash selling by some investors are evidence of the challenge involved in creating that smooth transition to retirement – and it’s a critical moment in a retiree’s investment journey.

Among the most difficult and consequential changes is the cessation of one’s regular salary. This utterly transforms the vulnerability of the portfolio: income stops; spending continues; recovery from a market decline is harder. It’s no wonder that new retirees experience “hyper risk aversion,” fearing the pain of market losses 10 times more heavily than they had as savers.1

Dangers of an untimely retirement: false starts and sequence risk

Risk aversion for many individuals peaks just prior to the start of retirement, and for good reason. Arguably the first and greatest danger for near-retirees is a bad beginning (just ask a runner). Timing also matters for the onset of retirement. Even one year can make or break success. For instance, identical investors (with identical portfolios), retiring 12 months apart (January 1972 and January 1973), would have had starkly different experiences in retirement – one nearly doubling portfolio assets over a 30-year period, the other exhausting assets just 23 years in (see Figure 1). An unfortunate sequence of returns, especially when a new retiree is coming out of the blocks, can severely hamstring portfolio performance. In some cases it can end the race well before it’s finished.

Figure 1 is a line graph that shows how the sequence of market returns can have a dramatic impact on how long a retirement portfolio lasts. For instance, identical investors (with identical portfolios), retiring 12 months apart (January 1972 and January 1973), would have had starkly different experiences in retirement over 30 years. The bottom line shows that an investor who began in 1972 would have exhausted their assets after just 23 years. In contrast, an investor who started in 1973 (the top line) nearly doubled their assets over 30 years and had a balance in excess of $1 million after 30 years. Sources are Bloomberg, Global Financial Data and PIMCO.

Dropping the baton: misbehaviors crystalize losses

Clearly a lot rides on avoiding a bad market sequence in the first years of retirement. But investor behavior may matter more. For instance, a rush to “safe haven” assets in the midst of a downturn can cause irredeemable damage. Market losses may put portfolios in a deep hole early in retirement; persistent spending from those assets may slow or stunt recovery. But an errant move to de-risk, or a rush to cash, typically at the worst point in the market’s decline, can crystallize losses, threatening the success of the retirement journey altogether. It’s the equivalent of fumbling the baton outright. Although staying in the race doesn’t guarantee success in down markets, losing precious time leaves little chance to catch up – even over a long retirement journey.