Why, For the Newly Retired, Stock Prices Matter Hugely
How to sidestep a bear market that comes at the wrong time
Among the best advice on retirement investing you’ll receive is to set your asset mix and then mostly ignore the ups-and-downs of the stock market.
But when your actual retirement date approaches — and you prepare to start living in part off of your investment — it becomes vitally important to realize whether you’re in an up or down stock market and to have prepared for the worst.
Pulling money out of your retirement accounts in the early going when stock values are down can serve as a portfolio gut-punch that may be hard to recover from. Stocks spring back, of course, and you want to preserve the amount you have that will rebound.
Bear markets and retirement
As Ben Carlson, a financial advisor who blogs at A Wealth of Common Sense,
recently pointed out that the value of a stock-only portfolio in 2000, assuming a retiree took out a 4% annual withdrawal that was adjusted for inflation each year (by 2%), would have been reduced by more than half by the end of 2020.
That’s because the S&P 500 fell in the first three years of the 21-year stretch: -9% in 2000, -12% in 2001, and -22% in 2002. (Then after five positive years, came the -37% decline in the 2008 bear market. Four down years in the first nine was not a great sequence.)
To be clear, the issue was the withdrawals. If there were no withdrawals the portfolio would have nearly quadrupled in value over that stretch.
Even though the annualized return of the S&P 500 stock index was 6.6% between 2000 and 2020, having that bad sequence early on meant withdrawals further depleted an already beaten down portfolio. Sort of like digging a hole deeper while you’re trying to get out of it.
Retiring amid a bull market
If the stock market is doing well in the early years of making withdrawals, the exact opposite happens: Even with annual withdrawals, you likely will end up with more money down the line.
To illustrate, Carlson reversed the annual returns from 2000-2020. He started with 2020 (up 18.4%), then year two was 2019 (+31.5%), year three was 2018 (-4.4%), year four was 2017 (+21.8%) etc. In this reversed sequence, the S&P 500 gained value in 11 of the first 12 years.
In reverse order, with the same assumed initial 4% withdrawal rate adjusted annually for 2% inflation, the portfolio value at the end of the 21 years had doubled. Not halved. Doubled. Simply because of a good sequence of returns.
Managing sequence-of-return risk
This is especially prudent for anyone who has recently retired or has it on a near-term to-do list, given the U.S. stock market is at record high levels.
To be clear, you still want to own stocks, given the solid chance your retirement might extend 25 or more years. Stocks, over long stretches, have delivered the best inflation-beating returns.
—Don’t bail on bonds. Ignore so-called market pundits who insist bonds are a bad investment because they currently have such low yields. Sure, less income is a challenge, but as a retiree you don’t own bonds just for their return potential. They are a vitally important diversification. When stocks fall, bonds gain in value or hold their value.
As Carlson pointed out, if you started withdrawals in 2000 from a portfolio invested 60% in stocks and 40% in intermediate term U.S. Treasuries, your balance at the end of 2020 was still more than you started with. Not half of what you started with, but more.
—Keep a bucket o’ cash. Another strategy is to keep two years of living expenses in cash. The rapid recovery of stocks from the pandemic bear market is not common. The average recovery time from bear markets going back more than 70 years is around two years.
—Be flexible. Managing to spend less in years when your portfolio takes a hit can reduce what you need to withdraw from retirement savings (beyond any required minimum distribution from 401(k) and IRA accounts).
—Cover essential costs from guaranteed income sources. Not having to rely on your stock portfolio for living expenses makes it easier to patiently wait out bear markets.
Delaying when you start Social Security is the surest way to boost guaranteed income in retirement. And using a portion of your portfolio to purchase a straightforward income annuity also delivers annual income.
—Consult with an advisor. The damage that can be done by a bad sequence of returns early in retirement can be planned around. But there are so many moving pieces — how much to keep in stocks, when to take Social Security, how much you can safely pull out of savings each year, when to know you need to temporarily scale back your retirement spending, are just a few — that working with a pro is likely one of the best investments you can make as you near retirement.
There are advisors who will take on “retirement income planning” as a project for a flat or hourly fee. Or you may find now is a good time to start working with someone on an ongoing basis.
And if you don’t run into a bad sequence of returns in the early going, be sure to reevaluate your plan every few years. If you have the good luck of a bull-market sequence of returns in the early going, you will likely be in a great position to increase your spending down the line.