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Why Taking Regular Withdrawals From a Retirement Account Can Be a Mistake

Putting your nest egg on autopilot can backfire during a bear market

Bear Market
24K-Production/Getty Images

Financial experts don’t always agree on much, but one thing they do agree on: Don’t take withdrawals from stock mutual funds in a bear market if you can avoid it. You’ll just make matters worse.

This is especially important to keep in mind if you are making automatic monthly withdrawals from your nest egg, as many retirees do. Although automatic withdrawals are handy, they can sometimes backfire when stocks are suffering sustained losses, as they have been this year.

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Count the cost

Bear markets, defined as a decline of 20 percent or more from the most recent market high, come with their own cruel calculus: To get back to even, you must earn a larger percentage than you lost. For example, if you lose 50 percent in an investment, you need to earn 100 percent to get back even. To get even from a 20 percent loss, you’ll need to earn about 25 percent to get where you were before the bear clawed your account. The S&P 500 index, the main gauge of U.S. stock performance, has fallen into a bear market in 2022.

Let’s say that on January 1, 2022, you had $100,000 in a low-cost, broad-based stock index fund. Good choice! You get diversification and don’t pay much in fees for it — and sometimes, nothing at all. But bear markets can be cruel. By the end of March, you had just $78,615 — a 21.89 percent loss, according to Morningstar, the Chicago investment trackers. If you panicked and moved your remaining money into a money market fund, you’d have to guess exactly when to get back into stocks — something that most investors mistime. In the meantime, you’d be earning about 2 percent on your investment.

Even if you’re determined to sell, you’re generally better off waiting a bit, says Sam Stovall, chief investment strategist at CFRA, a stock research firm. Bear markets end with a whimper, but bull markets start with a bang. “It has taken an average of only three months to go from the low to the 20 percent advance,” Stovall says. In addition, he says, the market typically rises an average of 40 percent in the 12 months after a bear market bottom.

Automatic withdrawal plans

Many funds offer automatic withdrawal plans, which will send you a check (or, more likely, an electronic deposit) of a set amount at regular intervals. It’s the opposite of an automatic investment plan, where you invest a set amount into a fund each month. While automatic withdrawal plans are fine in a bull market, they can be dangerous in a bear market. Here’s why:

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Once again, let’s say you had accumulated $100,000 in a stock fund. You decided to take 4 percent of the account each year, or $4,000, taken in monthly withdrawals of $333 ($4,000 divided by 12 months). You started taking withdrawals on the first of each month, beginning in January 2022.

Your July 2022 statement would reveal that your account was now worth $83,761, according to Morningstar, and you would be understandably upset. Without the withdrawals, your account would be worth about $86,000.

Each withdrawal you made increased your losses and reduced your account balance. Making matters worse, by withdrawing a set dollar amount, each withdrawal in a bear market means you’re selling more shares when the market falls, and fewer when it rises.

Over the long haul, the automatic withdrawal plan can make a big difference, and not necessarily for the better. Suppose you had begun your plan in October 2007, the eve of the greatest bear market since the Great Depression.

Consider a luckless investor who retired in October 2007, the start date of an epic bear market. He took $333 a month from his $100,000 account. By the end of the bear market in March 2009, his fund had lost about $50,000 — and he had reduced his portfolio by another $7,506 through withdrawals. By August 2022, his account would lag the untapped fund by more than $95,000 — not counting the $59,607 he had taken since he first began his withdrawals. And this scenario assumes he did not adjust his withdrawals upward for inflation, something that he would probably have to do.

What to do

Rather than take regular amounts from a stock fund, set aside about a year’s worth of withdrawals in a money market fund. In a $100,000 portfolio, that would be about $4,000; an ultracautious investor could set aside $8,000, enough for two years’ worth of withdrawals. (The average bear market lasts about 10 months.)

Invest the rest of your portfolio in a mix of stock and bond funds. The mix depends on how much risk you can stand. A typical mix commonly recommended by financial advisors for those around retirement age is about 60 percent stocks and 40 percent bonds. Once a year, review your holdings, and replenish your money market fund from the fund that has gained the most (or lost the least). “So, for example, this year we are getting funds from things that have increased, such as energy [stocks], but later you may rebalance by taking future withdrawals from other asset classes,” says Mark Bass, a certified financial planner in Lubbock, Texas.

If your portfolio has strayed from its initial allocation between stocks and bonds, you’ll need to rebalance, CFRA’s Stovall says. If you had set a mix of 60 percent stocks and 40 percent bonds for the portion of your fund that’s not in reserve for withdrawal, you’ll have to sell some of your winning holdings and add to your losing holdings. That’s not easy, especially after a bear market.

The current bear market started in January 2022, and we’re still in one. Typical bear markets last around 10 months. To return to bull market territory, the S&P 500 index would have to rise 20 percent from its bottom and stay there for six months, Stovall says. Until then, be as cautious as your budget allows about taking withdrawals from your stock funds, and if you’re in an automatic withdrawal plan, monitor it closely.