How You Can Protect Your Retirement Assets from The Next Market Drop
There are “two phases” of retirement planning. Accumulation and decumulation. Saving and Spending. Most everyone is familiar with saving money for retirement and most everyone is familiar with spending money but spending money when you do not have a job in retirement is challenging on many fronts.
First and foremost, how long will you live? How long will your spouse live? This is called our Longevity. While living longer can be a great thing it exposes retirees to many more risks in their retirement such as market risk but longevity risk or the risk of outliving your assets is the greatest risk of all as it multiplies all other risks.
Our Accumulation Years
During our working “accumulation” years while we are saving our money market risk and volatility is our friend. Markets go up and markets go down during those years. It’s the downturns that help us. When we are accumulating our assets we can buy more of the same asset at lower prices. Then once the asset goes back up, we make much more money because we bought lower prices. Often this is through 401k’s and IRA’s called “dollar cost averaging.”
Our Decumulation Years
There is a phase of retirement called our decumulation or our spending years. This is the period that we are at most risk and market volatility works against us. As the market goes down we still have to spend our money while in retirement. When it’s spent in those down markets it’s gone for good. Chances are if you are like a lot of retirees entering the “spending years”, you did not change much of what you’re doing. You’re investing the same way with the same advisor, and this could be a very treacherous path to take.
Sequence of Returns
When you’re in your spending phase of life, in retirement, it makes a retiree much more vulnerable to market downturns. There is a topic advisers should be discussing with new retirees called “sequence of returns.” This sequence of returns are the returns you get the first few years of your retirement and can have a great impact on the future viability of your retirement.
Sequence of Returns Works Like This:
If you retire in a down market and the market has a few years of negative returns say like in 2000 – 2002 the “internet bubble crash” where the market lost – 9.11% in 2000 and – 11.98% in 2001 and – 22.27% in 2002 that will completely devastate a portfolio. Those – 43.36% losses are completely locked in. You have no hope in recovery. In addition, what makes it much worse is that you are withdrawing an income during those years. Your situation is very dire.
On the other hand, if you were to turn those negatives into positives like since the 2008 crash when the market lost another -37.22 you could be in great shape.
It’s luck really. Do I retire in an upmarket or do I retire in a down market? Flip a coin.
Let’s Do An Example:
So, using the same period above, if you started in the year 2000 with a $1,000,000 account withdrawing just 5% each year to live on, that account just 3 years later during that period was worth $523,341.
Now I am no Ph.D. mathematician so I could be a few dollars off either way, but you get the point.
Half your value is gone in just the first three years of your retirement, and you will never make it back up. Ever.
It does not matter what size account you have. Half is half.
While this may be viewed by some as an extreme case isn’t that what you want your retirement account to be built upon?
But it’s really not extreme. Consider that the stock market had another – 57% decline just a few years later in ’07 – ’08.
If your account can withstand your lifestyle through that type of market you’re going to do just fine.
Let’s Do a General Illustration
So, let’s be moderate and assume a million-dollar nest egg and 5% withdrawal, $50,000 in income. If we assume a modest inflation rate of just 3.5% let’s take a quick look at two different scenarios.
This chart illustrates the upmarket or blue line, and the red line is retiring in a down market. Both accounts “average” the same exact 6% returns over the time period. The only difference is one retired in a down market, the red line, and the other retired in an upmarket, the blue line.
You see even though both retirees received the exact same returns overall, the one that experienced the negative returns at the beginning of retirement ran out of money 13 years sooner than the one who retired in an upmarket.
There are Strategies to Address Sequence of Returns Risk
There are a few strategies we employ for every single client to eliminate the Sequence of Returns risk. Overall though, some specific annuities can help. Repositioning a portion of your money to an annuity would take market volatility out of the picture. Annuities can be a great option for those looking for tax-deferred accumulation or guaranteed income.
Those retiring now or over the next five years have a much greater chance of retiring a down market. Those coming years will not be like the last five or even ten. As the below chart illustrates the stock market since 2008 looks like a hockey stick. There really has never been a worse time to retire. Interest rates have never been lower, the stock market has never been higher and the government has never printed so much money. It’s really going to be a tough time for retirees. If you don’t prepare for a major down market now while asset values are inflated, you may not be able to when it occurs or it will be at best, very sub-optimal.
Now is the time to put strategies in place, when the stock market is at highs, {up 550% since the 2009 crash}, real estate values are at highs and inflation is soaring and the FOMC is hoping to avoid a recession in the coming years. Take luck out of the equation.
