2. Accumulating and decumulating are not the same problem

Risk 8: Horizon, contributions and withdrawals

The previous module showed that the order matters when there are flows. This one explains why, with the same asset and the same fall, the investor who is accumulating and the one who is decumulating run exactly opposite risks. Not similar ones, not asymmetric ones: opposite.

Stop counting in euros and count in units

The trick for seeing this clearly is to abandon the balance and look at the number of units. A portfolio of 300,000 euros is 3,000 units of a fund priced at 100 euros. That investor needs 12,000 euros a year, 4% of the starting balance.

Suppose two symmetrical years: the price falls to 60 and then returns to 100, or else it rises to 166.67 and then returns to 100. In both cases the fund ends where it started and its two-year compound return is exactly zero.

The path with the fall first. At the end of the first year the fund is worth 60 euros and the portfolio 180,000. To take out 12,000 euros you have to sell 200 units. That leaves 2,800. In the second year the price returns to 100, the portfolio is worth 280,000, 120 units are sold and 2,680 units remain, 268,000 euros.

The path with the rise first. At the end of the first year the fund is worth 166.67 and the portfolio 500,000. To take out 12,000 euros, 72 units suffice. That leaves 2,928. In the second year the price returns to 100, the portfolio is worth 292,800, 120 units are sold and 2,808 units remain, 280,800 euros.

The difference is 128 units, 12,800 euros at the final price. And here is what matters: those 128 units do not exist. They are not hiding somewhere waiting for a recovery, they do not come back when the market perks up, no rally makes up for them. They were sold at 60 euros to pay the grocery bill and they vanished from the register.

The same asset, the risk the other way round

Repeat the exercise with an investor who contributes 12,000 euros a year instead of withdrawing them. With the fall first he buys 200 units at 60 euros and ends up with 3,320; with the rise first he buys only 72 and ends up with 3,192. The same 128 units of difference, now in favor of whoever suffered the collapse.

Read this slowly, because it is the central idea of the level:

• For the accumulator, an early fall is a discount. He buys more units for the same money and he has decades left for the price to recover. The only real risk is that he stops contributing out of fear.
• For the decumulator, that same fall is an amputation. He sells units at a sunken price and removes them from the game permanently, precisely when he has the most years of spending ahead of him.
• For the fund, nothing different has happened in the two cases. The risk is not in the asset: it is in the direction of the flow.

The withdrawal that goes up on its own

There is a second mechanism, quieter, that makes the first one worse. Our retiree decided to withdraw 12,000 euros a year when he had 300,000: 4%. After a 40% fall, the portfolio is worth 180,000 euros and that same 12,000 represents 6.7%. Without having changed his mind or his lifestyle, his effective withdrawal rate has risen by two thirds.

That turns the recovery arithmetic from the level on drawdowns into something considerably worse. A portfolio that loses 40% needs a 66.7% rise to get back to where it started if it is left alone. If on top of that 6.7% a year is being pulled out during that stretch, the bar goes up year after year, and the capital that has to produce that rise gets smaller and smaller. It is the same market and the same recovery percentage for everybody, but for the person withdrawing it arrives too late.

Why the first years are the worst

That the damage should concentrate at the start of the withdrawal phase has three causes acting at once.

First, the capital is at its maximum. A 40% collapse on 300,000 euros destroys 120,000; the same percentage fifteen years later, on an already depleted portfolio, destroys far less in absolute terms.

Second, the units sold cheaply were the ones with the most years of growth ahead of them. Selling at a sunken price in year 1 of a thirty-year retirement costs thirty years of lost compounding; doing it in year 27 costs three.

And third, there is no room for maneuver left. The accumulator can work two more years, contribute more or simply wait. The retiree has already spent his most valuable asset, which was time, and his only lever is cutting spending, which is precisely the decision nobody wants to take in the first year.

Hence a rule the literature repeats: the first five to ten years of withdrawal decide a good part of the outcome of the thirty. It is a narrow window in which an investor has little control over what happens and a great deal over how he is set up before it happens.

A real case: the lost decade

Consider someone who stopped working in the United States at the beginning of 2000, with a portfolio concentrated in US equities. The market fell three years running, with the S&P 500 losing around half its value between the 2000 peak and the October 2002 trough. Barely having recovered the ground by 2007, an even bigger fall arrived, of the order of 55% between October 2007 and March 2009. Adding dividends back in, the 2000-2009 decade ended slightly negative for that index, hence the nickname of the lost decade.

That retiree sold units for practically ten years in a market that was not rising, and reached 2010 with a number of units far below the initial one and therefore unable to take full advantage of the long bull market that followed. Whoever retired in March 2009, with exactly the same portfolio and the same withdrawal percentage, started selling at the launching point of one of the biggest rises in history. The only difference between the two was the calendar.