This year, retirees are handed an exceptionally tough hand and will need to play smart to avoid surviving the dwindling pile of money they’ve accumulated – the financial equivalent of going bankrupt in poker.
“Right now everything is negative – stocks, bonds and real estate,” said Charlie Farrell, managing director of Beacon Pointe Advisors’ Denver office.
Stock market corrections, defined as declines of 10% or more, and bear markets, declines of 20% or more, are fairly regular occurrences. What sets this market apart is that the most common hedging pension schemes used to offset these stock declines – bonds – are suffering historic losses due to rapidly rising interest rates.
Stocks are mostly in bearish 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 Greenwood Village wealth management firm.
“The bond market is on track for five times the worst year in its history,” Bills said. The asset class used to cushion stock market losses is performing almost as badly as stocks, which is unheard of. The storm refuge is submerged.
This means that people now approaching retirement may have far less money than expected and far less than is needed to achieve the goals they originally set for themselves.
A rule of thumb in retirement planning is to spend no more than 4% of a portfolio’s initial value each year. In a completely flat market with no gains or losses, that would be 25 years for someone, Farrell said. Earn a few 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, says that in today’s environment, 4% is too aggressive, and even 3% can be too aggressive.
To reinforce this argument, Finke, who was in Denver earlier this month, speaking to the National Association of Personal Financial Advisors, presented the risks of failure of a conservative portfolio consisting of 60% bonds and to 40% equities generating typical 4% yields on bonds. and 8% on shares per annum and with a management fee of 1%. He assumed a withdrawal rate of 3%, or $30,000 per year on a $1 million portfolio.
If someone retires in a 30% down year for stocks, that person would only have about a 50 to 50 chance of not running out of money in retirement. If the market is down 20%, which is the situation two months out of the year, the odds that money will last long enough are closer to 7 in 10. For those starting with a moderate 10% decline in inventory, the failure rate is just under 16%.
These probabilities are based on what is called a Monte Carlo simulation, which assumes different outcomes based on different scenarios. One way to think about it is to sit at a poker table where everyone is dealt a different deck of cards. Some hands are going to be winners and others losers right from the start. Anyone retiring right now has been roughed up.
Spend cash savings
One of the main ways to avoid taking a big hit in a bear market is to not sell assets and wait for the rebound – don’t lock in losses. Bear market or not, Bills recommends clients set aside 18 to 24 months of living expenses in a liquid emergency fund, which isn’t tied to volatile investments.
“It stays there, regardless of your allocation, and that saves you from having to sell,” he said.
Charlie Dunn, CEO of Intergy Private Wealth in Colorado Springs, goes even further. He recommends having five years of spending sources in “safe buckets” that don’t require the sale of 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 all the corrections we’ve seen other than the Great Depression,” he said.
But Farrell and others caution against investing too much money after the fact or trying to time the market. With inflation reaching 40-year highs, holding a large portion of retirement savings in cash year after year is not a winning strategy, at least to deal with rising costs. It remains a balancing act.
“The stock market has been the perfect place to grow your assets and outperform inflation over the long term,” added Joanna Heckman, vice president and financial consultant at Charles Schwab in Denver.
Work longer
Bear markets are usually associated with a recession, and recessions are usually associated with job losses, the kind that can cause older, better-paid workers to retire earlier than expected. But so far, this downturn is playing out in a very different way. Colorado’s unemployment rate remains at an all-time low of 3.4%.
Employers remain short of help, and while that could change in the coming months, a paycheck remains one of the surest ways to generate income and avoid dipping into savings. For those who can, one of the best ways to increase the long-term chances of retirement may be to not retire.
Bills said he had a conversation with a client on Tuesday who decided he still loved doing what he did and was going to wait another year to quit his job while the economy recovered.
“Whether you’re in a bear market or not, if you have the ability to continue earning income and can delay that retirement, consider it,” Bills said.
Farrell adds that doesn’t necessarily mean staying full-time. Part-time work can reduce the amount of retirement savings needed, while allowing someone to adjust to a reduced workload. Anything that provides income and eases the retirement portfolio is beneficial.
Decrease spending
The last thing people who have been saving for years to have money for retirement may want to hear is that they need to cut back on their spending, but this is a third way to deal with the new reality of retirement.
“Continuing to work is a very personal decision,” Heckman said. “Some people prefer to reduce their expenses.”
Celebrating retirement with a big splurge is quite common. It can range from buying a recreational vehicle to a dream trip abroad. But the current environment is one where it is worth delaying. Don’t eliminate, just delay.
So much is beyond investors’ control, Heckman said. They can’t control Federal Reserve policy or supply chain bottlenecks that drive up inflation or stock performance. But personal spending is one area where they have a say.
“In what areas can you reduce your expenses when the markets are difficult? How can you avoid making big withdrawals? ” she says. 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 could ease interest rates too soon and the economy could see waves of sustained inflation lasting for years. The last time this happened was in the 1970s and stock market returns stayed flat for over a decade. Or the Fed may hold the brakes on for too long, triggering a severe recession and an even steeper correction in bonds and stocks.
“During this period you have to decide how much risk you want to take with the uncertainty that is being created,” he said. “Know yourself as you go through this cycle. Set yourself up to deal with uncertainty.