Monday, March 30, 2020

How a Retirement Plan Responds to Market Volatility

To illustrate my retirement plan in action, let’s go through an example of how it handles a big stock market drop. My plan certainly isn’t for everyone, but you may find elements of it you like. Hopefully, this post is what reader KT had in mind when asking for a detailed example.

Imagine a hypothetical couple, the Carsons, who are following the same retirement plan my wife and I are following, but they’ve just turned 70, so they’re much further along than we are. Our portfolio is currently split 80/20 between stocks and fixed income, but this will change to 76/24 by the time we’re 70. So the Carsons’ current asset allocation is 76/24.

The Carsons deferred both their CPP and OAS to age 70. In total, they get $4000 per month or $48,000 per year. If this sounds high, then welcome to the power of deferring CPP and OAS. They could be getting a lot more if they both got maximum CPP benefits.

The Carsons have a million dollar portfolio ($760,000 in stocks and $240,000 in fixed income). The fixed income portion represents 5 years of their safe spending level, or $48,000 per year (4.8% of their portfolio). With CPP and OAS, this is a total of $96,000 per year. Like my wife and I, the Carsons actually spend less than this. They saved up more than they needed to give them a cushion before they retired years ago.

Before they retired, the Carsons always spent from the income of the spouse making more money. So their assets and income in retirement are nearly equally split between them. And some of their spending comes from non-registered accounts and TFSAs. So, they each declare a little under $45,000 in income per year. This means their income taxes are quite low.

The Carsons aren’t concerned about being forced to take more than they want out of their RRSPs each year. They’ll just save any excess in their TFSAs or non-registered accounts. It sometimes takes some juggling, but as long as the total amounts across all their accounts add up to their 76/24 asset allocation, all is well.

Each month, the Carsons spend from their fixed-income savings. Whenever their desired fixed-income amount is off by more than 10%, they rebalance. Their current fixed-income target is $240,000. So, if it is ever 10% too high (above $264,000), they buy some stocks. Whenever it is 10% too low (below $216,000), they sell some stocks. When markets are calm, their fixed-income allocation gets too low a couple of times per year, triggering rebalancing.

Unfortunately for the Carsons, their stocks recently dropped 25%. This sudden market crash has many people fearful and trying to decide what to do in response. The Carsons decided to just stick with their plan.

Their stocks are down to $570,000, and with little change in their fixed income savings, their total portfolio is worth $810,000. Their fixed-income allocation should now be 24% of this, or $194,400. So, it is too high by $45,600. This is more than 10% off, so the Carsons rebalance by using $45,600 of their fixed income savings to buy stocks.

With their portfolio going down, the Carsons’ safe spending level dropped to 4.8% of $810,000, or $38,880 per year. Adding in their CPP and OAS, their safe spending level dropped from $96,000 to $86,880 per year. This is a substantial drop. Fortunately, the Carsons weren’t spending their whole $96,000 each year, so the reduction isn’t too painful.

Let’s assume that stocks stay down for a year before starting to rise again. During that year, the Carsons can spend up to $38,880 from their portfolio (plus their CPP and OAS benefits). When their fixed-income allocation drops 10% below its target, they’ll sell some stocks. But remember that they bought $45,600 worth of cheap stocks right after the market crash. During this whole sideways year for the stock market, they won’t have to sell any of the stocks they had before the crash.

Hopefully, this answers a question reader Art had. In an earlier post, I answered Art’s question of what to do about the recent stock market crash. He expected that after a market crash I’d hunker down leaving my stocks alone, spend exclusively from fixed income, and wait for stocks to rebound. When I said I am maintaining my asset allocation, he followed up by asking what role the fixed-income component plays in this case.

One answer is that it reduces my portfolio’s overall volatility. Another answer as suggested by the worked example above is that the rebalancing process automatically halts the selling of stock for a period of time. In this example of a 25% stock price drop, the Carsons don’t touch the stocks they had before the crash for just over a year. In a more severe decline, the stocks remain untouched longer. This protects a portfolio against having to sell stocks after violent price drops.

So, why don’t I just hunker down and not do any stock trading at all until stocks rebound or all the fixed income money is gone? The answer is that I find this to be too much of an all-in bet. It works very well when stocks cooperate and rebound in time. But what if stocks crash again as your fixed-income money runs out? Now you’re in trouble having to sell stocks when they’re very low. I prefer to maintain the moderating effect of having my fixed-income allocation intact.

During the long bull market leading up to the stock crash, the Carsons had to sell stocks frequently to maintain their fixed-income allocation at its target. A big benefit of sticking to your asset allocation is that it has you selling stocks while they’re high and later buying them when they’re low. The benefit of this buying low and selling high partially compensates for the opportunity cost of not being 100% in stocks.

So, even if my approach can’t protect my stocks for a full five-year bear market, it can protect them for a year or so, depending on the severity of the market crash. I’m giving up some protection against a 5-year bear market to perform better in an unusually long-term bear market. Others may make a different choice.


  1. Very informative writeup, as usual. It seems as though you use a moving safe spending rate (you're probably not at 4.8% at your age right now). How is this rate determined? If it comes from an official study, can you share it?

    1. Hi Ferd,

      I get the safe spending level by calculating what withdrawal rate would deplete a portfolio by age 100, with stocks and fixed income getting known real returns. The following post has a link to a spreadsheet you can copy and modify to produce your own safe withdrawal rate:

      The key is to choose appropriately conservative figures for age at death, real investment returns, and years of fixed income savings.

      I've chosen my own figures that are fairly close to the ones in the spreadsheet I mentioned above.

  2. In your example, didn't the Carsons take $48K for their first year spending out of the original $240K? So after the stocks crashed by 25%, the portfolio is actually $570K + $192K = $762K. If they were to use the 4.8%, the withdrawal amount for the next year would be $36576. 5 years of $36,576 is $182,880, so they'd move $10K into the stock market and not $45K.

    1. Hi Dan,

      I don't do full-year withdrawals from my portfolio all at once. I just spend the appropriate amount each month from my fixed income. If that causes my fixed income allocation to get too low, I rebalance as necessary. So, instead of yearly big withdrawals, I have more of a continuous model that is managed by my spreadsheet.

      However, it's easier for most people to use the annual withdrawal method. In this case, you can think of the 25% drop in stocks as having happened just before the annual withdrawal date. So, the Carsons were running out of spending money just as their $760,000 / $240,000 portfolio turned into a $570,000 / $240,000 portfolio. They rebalanced, and then made their annual withdrawal. I didn't give enough information to tell what their portfolio was like a year earlier, so we don't know how large their annual withdrawal was the year before.