Why 2022 was a dangerous time to retire – and what to do about it

The S&P 500 Index is down nearly 17% in 2022. The index fell into a bear market at one point on Friday (meaning the US stock index was down more than 20% from its recent high in January) before recovering a bit.

The Bloomberg US Aggregate Bond index is also down more than 9% this year. Bond prices move opposite to interest rates, a dynamic that has strained bond funds The Federal Reserve raises its key rate.

Investors are most vulnerable to market shocks in the early months and years of retirement.

This is due to the “sequence of returns” risk. Someone who withdraws money early in retirement from a declining portfolio is more likely to exhaust their nest egg too soon, compared to a retiree who experiences a market downturn years later.

When the market goes down, it means investors need to sell more of their investments to generate income. This depletes savings faster and leaves less room for growth when things bounce back, hampering a portfolio meant to last for decades.

The “sequence” – or timing – of returns on investment is what is important.

consider this Example from Charles Schwab of two new retirees with $1 million portfolios and annual withdrawals of $50,000 (adjusted for inflation). The only difference is when each suffers a 15% portfolio loss:

One registers a 15% decline in the first two years of retirement and a 6% gain each year thereafter. The other has a 6% annual gain for the first nine years, a negative 15% return in years 10 and 11, and a 6% annual gain thereafter.

The first investor would run out of money after 18 years, while the other would have around $400,000 left over.

“If you’ve been planning for 30 years [of retirement]those early years could be really important in terms of what you end up going through for your outcome,” Blanchett said.

Of course, some retirees are more vulnerable than others.

For example, a retiree who receives all or most income from Social Security, pensions, or annuities is largely unaffected by what happens in the stock market. The amount of these funds is guaranteed.

Also, the risk associated with the sequence of returns is probably less important for someone retiring at a later age, as their portfolio will not need to last as long. Nor is it likely to greatly affect a retiree who has saved far more money than necessary to fund his lifestyle.

On the one hand, they can reduce their spending, thereby reducing withdrawals from their nest egg. Follower of “4% rule“strategy might choose to forego an inflation adjustment, for example – although there is many different schools of thought regarding spending retired.

Regardless of the strategy, the reduction in withdrawals puts less stress on the investment portfolio.

“Does that mean you can’t go on a fun cruise or vacation? Not necessarily,” Blanchett said. “It requires thinking more about the trade-offs, potentially, depending on how things go.”

Similarly, retirees can restructure the source of their withdrawals. For example, to avoid withdrawing money from stocks or bonds (categories that are in the red this year), retirees can instead withdraw cash.

This comes down to sequence risk and trying not to make money from assets that are falling in value. Drawing from a bucket of cash while waiting for other assets to recover (hopefully) helps achieve this goal.

“You don’t want to sell stocks or bonds in this environment if you can afford it,” said Christine Benz, director of personal finance at Morningstar.

However, retirees may not have months or years of cash on hand. In this case, they can tap into areas that have not been hit as hard as others, for example, perhaps in short or medium-term bond funds, which are less sensitive to rising rates. of interest.

Workers who have not yet retired (and are concerned about having enough money to do so) can choose to work a little longer, if possible. Or, they can think about earning a side income once they retire to put less pressure on their nest egg.

Reducing the demands on your investment portfolio is one of the most important things you can do, Benz said. For example, Social Security beneficiaries receive a guaranteed annual boost of 8% to their benefits each year, they delay claiming full retirement age. (This 8% increase stops after age 70, however.) Seniors who can delay get a permanent increase in their guaranteed annual income.