For anyone who is about to retire and look nervously at the stock market, these tremors may mean it’s time to review your portfolio.
While stocks over time provide the best opportunity for long-term growth despite periods of volatility, a sustained market decline on the road to retirement can be problematic if you leverage these assets for income.
Basically, research shows that the long-term damage this does to your portfolio can be significant. Experts recommend ensuring that your money is allocated in a way that reduces this risk.
“One of the things I’ve seen too much of is retirees being invested too aggressively early in retirement,” said certified financial planner Carolyn McClanahan, founder of Life Planning Partners in Jacksonville, Florida.
A combination of high inflation, the war in Ukraine and impending interest rate rises have caused the major indices to continue to zigzag their way through a setback. Year to date, the S&P 500 index – a broad measure of how US companies are doing – has fallen about 10% until Friday at noon. The Dow Jones Industrial Average has fallen about 6.5% so far this year, and the technology-laden Nasdaq Composite Index has fallen 18%.
Over the past 12 months, however, S&P has risen more than 4%, the Dow has risen about 1.1%, and the Nasdaq loss is around 6.1%. Although it is impossible to predict where the market will go from here, volatility is expected to continue.
For long-term savers – those whose pensions are many years or decades away – stock market ups and downs generally mean less because their portfolios have time to recover before they can rely on their cash flows.
That’s another story in retirement. And for those who have just begun that chapter of life, this can be a particularly acute problem.
Basically, a “sequence of return” risk can have a long-term negative impact on your portfolio. This risk is basically about how the order or order of your losses or gains over time matters when you settle investments.
The chart below illustrates the difference that market losses versus market gains early in retirement can have. In the chart, both portfolios have the same investments and experience the same annual return, but in reverse order over 25 years.
Both hypothetical portfolios start at $ 100,000 and experience $ 5,000 annual retirements, but Portfolio A begins with a sequence of negative returns, and Portfolio B has these losses at the end of 25 years. The difference is significant: Portfolio A has been exhausted before year 20, and Portfolio B ends up with more than twice as many assets as it started with.
“It’s really important for today’s retirees and early retirees to understand [that risk] to their nest eggs, “said Vance Barse, wealth strategist and founder of Your Dedicated Fiduciary, which has offices in San Diego and Prosper, Texas.
If your planned retirement date is approaching, it’s worth checking to see if your portfolio is designed in a way that addresses this sequencing risk. Generally, this means that you are trying to keep the money you need to cover your expenses away from stocks and other riskier investments.
Some advisors recommend having one or two years of cash or cash on hand to avoid selling to a low market.
“Make sure you have enough cash so you do not have to sell yours [investments] to have cash, “said David Peterson, head of wealth planning at Fidelity Investments.” You do not want to do that in a declining market. “
Part of knowing how much cash you really need means having a good grip on both your other sources of income – ie. social security, pension, annuities – and your actual expenses.
“A lot of people inadvertently minimize their expenses,” Barse said.
In addition to having cash, it is worth making sure that the rest of your assets are not over-invested in stocks.
McClanahan said her retired clients maintain five years of conservative investment to meet cash flow needs.
“That way, they do not have to wait for a miserable market to figure this out,” McClanahan said.
She said that for new retirees whose savings are just enough – ie. there is not much room for error – a conservative portfolio consisting of 50% equities and 50% bonds may be appropriate.
“But we have some customers who only have 30% or 40% in stocks,” McClanahan said. “It’s about how much risk you can take financially and mentally.”