For anyone nearing retirement and nervously watching the stock market, that nervousness may mean it’s time to review your portfolio.
While stocks offer the best opportunity for long-term growth despite periods of volatility over time, a prolonged market downturn leading into retirement can be problematic if you’re using these assets for income.
Basically, research shows that the damage this does to your portfolio over the long term can be significant. Experts recommend making sure your money is allocated in a way that reduces this risk.
“One of the things I’ve seen too often is retirees being invested way too aggressively into retirement early,” said certified financial planner Carolyn McClanahan, founder of Life Planning Partners in Jacksonville, Fla.
A combination of high inflation, the war in Ukraine and imminent rate hikes has caused major indices to continue zigzagging through a pullback. Year-to-date, the S&P 500 index — a broad measure of how U.S. companies are doing — is down about 10% as of midday Friday. The Dow Jones Industrial Average is down about 6.5% so far this year, and the tech-heavy Nasdaq Composite Index is down 18%.
However, over the past 12 months, the S&P is up more than 4%, the Dow is up about 1.1%, and the Nasdaq is down about 6.1%. While it is impossible to predict where the market will go from here, volatility is expected to continue.
For long-term savers — those whose retirement is many years or decades away — stock market ups and downs are generally less important because their portfolios have time to recover before they can rely on cash flow.
Retirement is different. And for those just beginning this stage of life, this can be a particularly acute problem.
In general, “return following” risk can have a long-lasting negative impact on your portfolio. Essentially, this risk is about how the order or sequence of your losses or gains matters over time when you liquidate investments.
The chart below illustrates the difference that market losses can make versus market gains in early retirement. In the chart, both portfolios hold the same investments and generate the same annual returns, but in opposite order over 25 years.
Both hypothetical portfolios start with $100,000 and experience $5,000 in annual withdrawals, but Portfolio A starts with a string of negative returns and Portfolio B has these losses at the end of 25 years. The difference is striking: Portfolio A is used up by year 20, and Portfolio B ends up with more than double the assets it started with.
“It’s really important for today’s retirees and early retirees to understand [that risk] to their nest egg,” said Vance Barse, wealth strategist and founder of Your Dedicated Fiduciary, with offices in San Diego and Prosper, Texas.
As your planned retirement date approaches, you should review whether your portfolio is constructed to accommodate this sequencing risk. Generally, this means trying to keep the money you need to cover your expenses away from stocks and other riskier investments.
Some advisors recommend having a year or two’s worth of cash or cash equivalents on hand to avoid selling in a falling market.
“Make sure you have enough cash so you don’t have to sell yours [investments] Having money,” said David Peterson, head of wealth planning at Fidelity Investments. “You shouldn’t do that in a declining market.”
To know how much cash you really need, you need to have a good handle on both your other sources of income – ie Social Security, retirement, pensions – and your actual expenses.
“A lot of people inadvertently minimize their spending,” Barse said.
Aside from having cash, you should make sure that the rest of your wealth isn’t heavily invested in stocks.
McClanahan said her clients are making five years’ worth of conservative investments as they retire to meet cash flow needs.
“That way they don’t have to wait until some crappy market to find out,” McClanahan said.
She said that for new retirees whose savings are just enough – meaning there isn’t much room for error – a conservative portfolio of 50% stocks and 50% bonds might be appropriate.
“But we have some clients that are only 30% or 40% invested in stocks,” McClanahan said. “It’s about how much risk you can take financially and psychologically.”
https://www.cnbc.com/2022/04/22/getting-close-to-retiring-be-sure-you-are-managing-this-risk.html Nearing retirement? Make sure you manage this risk