How does one keep track of their gains or losses while at the same time accounting for permanent losses from portfolio withdrawals?
Let say I have $100K and I plan on withdrawing 4% or $4K in year one of retirement and I do that Jan 1 of that first year. My balance is now effectively $96K as a result of the distribution. To me this is a permanent loss because I am spending, not saving that 4%. Obviously my bookkeeping accounts for this withdrawal until I spend it. Maybe I buy a car with this 4% and the car goes up in value after I buy it. Maybe I blow it on Jan 2 at the casino...ouch... but these are the dynamics of spending down your portfolio. You may have something (a car worth at least $4k) or you have nothing more than a recollection of the $4K withdrawal.
If my overall portfolio drops 10% soon after Jan 1, I now have $86.4K. My hope is that over the next 3-5 years I will recoup that 10% market loss, but I realize my withdrawal rate (4%) is now greatly impacted by my eventual portfolio balance come Jan1 of the next 3-5 years.
Segregating 5 years worth of withdrawal might act as a drag on my potential upside performance, but might hedge my downside potential. Five years of withdrawal that include a 2% inflation adjustment would amount to $20.8K. It might be prudent to keep this amount in a conservative investment with little downside risk. That leaves a little less than $80K invested for the longer term (5 years). An average 5 year return of 5.8% would return this portfolio to its $100K value, but inflation requires a 7.9% average return in order to keep the same buying power.
Seems to me that in retirement one needs segregate "withdrawal assets" (maybe up to 5 years worth) from "market assets". This way your withdrawals are not necessarily connected to the market's ups and downs. In 5 years, a new calculation will determine what the nest 5 years of "withdrawal assets" will amount to.
If your are managing these dynamics in retirement please share your strategy.