Will 2016 bring a repeat of the market meltdowns in 2000 and 2008?

“This is one of the central investing questions of today as it pertains to the major issue for those in and approaching retirement,” says Richard S. Marcatos, senior vice president, wealth management, with UBS Financial Services in Clearwater, Fla.

The issue is “sequence-of-returns risk,” or sequence risk.

Asset values may rise and fall, as they have for years. However, if “fall” years occur right before or right after retiring, a portfolio in draw-down stage might be depleted much sooner than it would after a similar drop many years later.

“A major market correction or lower-than-historical returns in either bonds or equities can have significant long-term consequences,” says Thomas B. Moran, founder and managing director of Moran Edwards Asset Management Group of Wells Fargo Advisors in Naples, Fla.

Bucket List

To address this risk, Marcatos suggests setting up three or more distribution “buckets,” with different assets and different time horizons for liquidation. These should be in place well before retirement, when an investor is “more detached” from distribution issues.

“The first bucket, holding low-volatility assets, will provide for immediate cash flow needs for a set period of time, commonly two years,” Marcatos says. “If a bear market hits at the beginning of withdrawals the investor usually will be more comfortable using the cash distribution bucket and sleep better on the expectation that the bear market will not lead to ill-advised investment liquidations.”

Bucket two typically is balanced between equities and bonds, while bucket three is focused on long-term growth and possible legacy assets for heirs, Marcatos adds.

Playing the Percentages

“Once the buckets are set up, retirees should have a spend-down strategy,” Marcatos says. “If the objective is to determine an appropriate spending level expected to sustain an inflation-adjusted spending rate during a typical 30-year time horizon, then the sequence-of-investment returns are critical.”

Since 1870, safe withdrawal rates for a retired investor's portfolio with 60% stocks and 40% bonds have ranged from 4% to 10%, with the median around 6.5%, according to Moran.

“These withdrawal rates are highly dependent on a retiree's investment experience in the first 10 years of retirement,” he says. “If a retiree experiences significant over or underperformance in the early years of retirement, adjustments need to be made when calculating a sustainable withdrawal rate.”

The rate might move up or down, reflecting changing portfolio values.

Moreover, draw-down planning shouldn’t wait for the last paycheck.

“An initial withdrawal strategy should be in place at least five years prior to the first distribution,” Marcatos says. “During this time, if assets rise to very attractive levels, investment gains can be strategically harvested.”

Profits might be reinvested to provide a cushion against a potential pullback.

Donald Jay Korn is a New York-based financial writer who contributes to On Wall Street and Financial Planning.

This story is part of a 30-day series on retirement planning strategies.

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