What If This Turns Out to Be a Terrible Time to Retire?
Key steps to consider as you approach retirement.
Assets in IRAs and defined-contribution plans hit $16.3 trillion last year, up over 80% from 2010 levels according to the Investment Company Institute.
No doubt owing to their swollen balances, employees are also growing more confident in their ability to retire: To wit, 67% of employees surveyed in the Employee Benefits Research Institute annual survey said that they are somewhat or very confident in their ability to retire—up from just over 50% in 2009.
However, the same forces that are fueling retirement confidence have the potential to work against new retirees in the years ahead. Employees are more likely to retire when the market is cresting. Somewhat counterintuitively, that has the effect of reducing a portfolio’s sustainability, unless the new retiree steers most of his assets out of equities and into less risky asset classes.
Of course, bumps in the road are inevitable in any investing horizon of 25 or 30 years: Indeed, the past 19 years have been pockmarked by two major bear markets. But for new retirees, those downturns can prove especially painful—even devastating—for retirement plans. The reason is what is known as “sequence of return risk” whereby big market losses early in retirement are far more impactful than later in retirement. To illustrate, look at the portfolio values over time for Frank and Dale below. Both start out in retirement with $2 million and withdraw $80,000 for living expenses in the first year and increase that amount each year by inflation (assumed to be 3%). Their portfolios both have an average return over the 20-year period of 7.0% and the exact same annual returns in each of the 20 years. However, Dale’s portfolio is gone by year 16 of retirement while Frank’s has actually more than doubled after 20 years. The difference is simply the sequence of returns. Frank’s portfolio enjoyed a bull market run in the first 5 years and a sharp bear market in the last 5 years. Dale’s portfolio experienced the exact same markets but in the opposite order: His first 5 years were marked by a sharp bear market and by the time the bull market phase came along his portfolio was gone.
While no one can control market movements, there are a few tactics retirees can use to limit the damage that a bear market in early retirement can have on their portfolios. Here are some of the key ones to consider.
1. Delay the date but not the gratification
If you are considering retirement but concerned about eliminating your paycheck in a lofty market that could experience a downturn, one option is to start with a work/retirement hybrid. This involves pursuing work that is less remunerative but perhaps more meaningful or enjoyable prior to retiring for good. An alternative option is to “pre-retire” whereby you continue in your job but spend additional retirement contributions on travel and leisure pursuits rather than save them. Those late-in-life retirement-plan contributions are less meaningful, from the standpoint of compounding, than those made early on. Meanwhile, the benefits of delaying retirement greatly improve a portfolio’s long-term sustainability.
2. Seek portfolio balance
Another means to help circumvent sequencing risk is to begin retirement with a conservative allocation to equities and increase it over time. Once you are safely through the danger zone of losing a lot of money in the early retirement years, you can then increase equity exposure in the portfolio. Correspondingly, you can set aside a healthy contingent of your portfolio in safer securities like cash and high-quality, short- and intermediate-term bonds. Then, if you do encounter a weak market environment right out of the box in retirement, you can spend from the stable assets while leaving the more volatile assets in place to recover.
3. Maintain discrete holdings to retain rebalancing opportunities
In even the worst market conditions, something in a well-diversified portfolio is likely to be doing reasonably well. In 2000, it was value stocks; in 2008, government bonds gained ground. By holding discrete positions in equities and bonds (as opposed to mutual funds), appreciated positions provide an opportunity for you to prune that portion of the portfolio to use for spending, to refill cash reserves, or to put into depreciated positions. This helps ensure that you never have to tap a position when it is down.
4. Adjust spending downward when encountering retirement turbulence
The early retirement years are also the high spending years, on average, when retirees sate their pent-up demand for travel and leisure activities. But, if you possibly can, rein in your spending amid market downturns. Market volatility in retirement can cause queasiness and a sense that things are out of your control; reducing spending is a way for you to take back some measure of control amid the uncertainty.
These are just some of the tactics to manage your nest egg in retirement. To learn more, or to develop your retirement income plan, meet with your Financial Advisor.
© Morningstar 2019. All Rights Reserved. Used with permission.
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