Retirees this year are being dealt an unusually tough hand and will need to play it smart to avoid outliving the dwindling pile of money they have accumulated — the financial equivalent of going bust in poker.
“Right now we have everything moving negative — stocks, bonds and real estate,” said Charlie Farrell, managing director of the Denver office of Beacon Pointe Advisors.
Stock market corrections, defined as declines of 10% or more, and bear markets, down 20% or more, are fairly regular occurrences. What sets this market apart is that the most common hedge retirement plans use to offset those stock declines — bonds — are suffering historic losses because of rapidly rising interest rates.
Stocks are mostly in bear market territory. The Barclays Aggregate Bond Index, a measure of fixed-income performance, is down 16% this year, said Scott Bills, CEO of Nilsine Partners, a wealth management firm in Greenwood Village.
“The bond market is on track to have its worse year in history by five times,” Bills said. The asset class used to buffer against stock market losses is performing almost as badly as stocks, which is unheard of. The safe haven against the storm is swamped.
What that means is people who are now entering retirement may have a lot less money than expected, and a lot less than they need to meet the goals they had originally set.
A rule of thumb in retirement planning is to not spend more than 4% of a portfolio’s original value each year. In a completely flat market, with no gains or no losses, that would last someone 25 years, Farrell said. Earn a couple of percentage points above inflation, which isn’t too hard to do in most years, and that nest egg can outlast most retirees.
But Michael Finke, professor of wealth management at The American College of Financial Services, argues that in today’s environment, 4% is too aggressive, and even 3% may be too aggressive.
To bolster that argument, Finke, who was in Denver earlier this month speaking at the National Association of Personal Financial Advisors, presented the chances of failure on a conservative portfolio that is 60% bonds and 40% stocks earning typical returns of 4% on bonds and 8% on stocks a year and with a 1% management fee. He assumed a 3% withdrawal rate, which is $30,000 a year on a portfolio of $1 million.
If someone retires in a 30% down year for stocks, that person would only have around a 50-50 chance of not running out of money in retirement. If the market is down 20%, which is where things are at with two months to go in the year, then the odds of having the money last long enough are closer to 7 in 10. For those who start out with a moderate 10% decline in stocks, the failure rate is just under 16%.
Those probabilities are based on something known as a Monte Carlo simulation, which assumes different outcomes based on different scenarios. One way to think of it is sitting at a poker table where everyone is dealt a different set of cards. Some hands are going to be winners and some losers from the get-go. Anyone retiring right now has been dealt a very ugly hand.
Spend cash savings
One key way to avoid taking a hit in a down market is to not sell assets and wait for the rebound — don’t lock in losses. Bear market or not, Bills recommends his clients have 18 to 24 months of living expenses set aside in a liquid emergency fund, one that isn’t linked to volatile investments.
“It sits there no matter what your allocation is, and it keeps you from having to sell,” he said.
Charlie Dunn, CEO of Intergy Private Wealth in Colorado Springs, takes it even further. He recommends having five years of spending sources in “safe buckets” that don’t require selling off assets. Beyond an emergency fund, those buckets would include income streams from things like interest payments, dividends, and rents on real estate investments.
“Five years would have gotten you through every correction we have seen other than the Great Depression,” he said.
But Farrell and others caution against going too heavily into cash after the fact or trying to time the market. With inflation running at 40-year highs, holding a significant portion of retirement savings in cash year after year isn’t a winning strategy, at least in terms of keeping up with rising costs. It remains a balancing act.
“The equity market has been the place to grow your assets and outperform inflation long term,” added Joanna Heckman, a vice president and financial consultant with Charles Schwab in Denver.
Bear markets are typically associated with a recession, and recessions are usually associated with job losses, the kind that can push older and higher-paid workers into retirement sooner than expected. But so far, this downturn is playing out much differently. Colorado’s unemployment rate remains a historically low 3.4%.
Employers remain short of help, and while that could change in the months ahead, a paycheck remains one of the surest ways to generate an income and avoid drawing down savings. For those who can do it, one of the best ways to boost the long-term odds in retirement may be to not retire.
Bills said he had a conversation with a client Tuesday who decided he still enjoyed doing what he does and was going to wait another year to quit his job while the economy sorted itself out.
“Whether you are in a bear market or not, if you have the ability to continue making income and can delay that retirement, consider it,” Bills said.
Farrell adds it doesn’t necessarily mean staying on full-time. Going part-time can lower the amount of retirement savings needed, while also allowing someone to ease into a reduced workload. Anything that provides income and takes the pressure off the retirement portfolio is beneficial.
The last thing people who have scrimped for years so they had money to retire may want to hear is that they need to cut back on spending, but that represents a third way to tackle the new retirement reality.
“Continuing to work is a very personal decision,” Heckman said. “Some people would rather pare back their spending.”
Celebrating retirement with a big splurge is somewhat common. It could range from buying a recreational vehicle to taking a dream trip abroad. But the current environment is one where it pays to delay. Not eliminate, just delay.
So much is out of the control of investors, Heckman said. They can’t control Federal Reserve policy or supply-chain bottlenecks that drive up inflation or how stocks will perform. But personal spending is one area where they have some say.
“Where are areas you can decrease your spending when markets are tough? How can you avoid making large withdrawals?” she said. The delayed gratification that allows for the accumulation of retirement savings can also help recent retirees weather the current downturn and put them in a better position for long-term success.
Farrell said there is so much uncertainty right now. The Federal Reserve may let up on interest rates too soon and the economy could see rolling waves of sustained inflation lasting for years. The last time that happened was in the 1970s and stock market returns went nowhere for over a decade. Or the Fed may keep the brakes on for too long, triggering a severe recession and even steeper correction in both bonds and stocks.
“In this period, you have to decide the amount of risk you want to take with the uncertainty that is building,” he said. “Know yourself as you go through this cycle. Put yourself in a place to deal with uncertainty.”
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