Roughly 10,000 baby boomers retire daily. If you are within a year or two of retirement you may have concerns about a major downturn in the stock market. Many individuals delay retirement because they don’t fully understand stock market risk, or sequence of returns risk and ways to reduce its impact on their retirement plans.
When you shift from working and investing to retirement distributions, the story can change.
While you are saving in your 40’s and 50’s it can be easier to ignore the stock market. When you are a year away from retirement you might be checking your portfolio daily and asking whether you have ‘enough’. It’s easy to fall into this pattern. After all, when most folks retire, they live predominantly off their investment portfolios and social security.
Depending on when you retire, there is some risk that the beginning of retirement withdrawals from your portfolio could coincide with a period of declining prices. You should work with your advisor to plan for this challenge.
As I draft this article, the returns for the largest 500 U.S. stocks as measured by the S&P 500 index were:
While stocks were down almost 5% during 2018, the recent three year 21.9% average annual return for large U.S. stocks masks the underlying fluctuations in value. During the beginning of the Covid-19 pandemic the S&P 500 fell 20% during the first 3 months of 2020. Imagine if you had $2 million of your retirement portfolio in US stocks and it fell to $1.6 million in a 3 month period. This illustrates the perils of sequence of returns risk, which occurs when the market’s returns at a specific time are unfavorable, even if that volatility averages out into favorable returns during the long term.
In an extreme illustration, consider the 2007-2009 bear market. Picture a hypothetical retiree entering 2008 with a $1 million portfolio. The portfolio holds 60% in equities and 40% in bond (fixed-income) investments. The investor was preparing to retire at the end of the year, but by the end of 2008, the bond market –– as measured by the S&P U.S. Aggregate Bond Index –– rose 5.7% while the stock market –– as measured by the S&P 500 Index –– lost 37.0%. The investor’s $1 million portfolio ended the year with a balance of $800,800.
If our hypothetical retiree started taking distributions in January 2009, they would be starting from a smaller portfolio balance and might be very concerned about the reduction in value over the prior 12 months.
If your portfolio fell $400k, would you still feel comfortable withdrawing money from your portfolio for retirement? Would you sell stocks or bonds from your portfolio? Or, would you have planned ahead for these normal portfolio value changes?
One strategy to reduce the risk of a stock market downturn derailing your retirement is to use a Cash Bucket Strategy as part of your portfolio. This means having 3 years of cash or low risk bonds set aside to meet spending needs in the first few years of retirement. That way, you are not selling stocks during a downturn. In addition to a Cash Bucket, your retirement portfolio should have an Income Bucket and a Long Term Growth Bucket to combat inflation.
One strategy to reduce the risk of a stock market downturn delaying your retirement is to have 3 years of cash or low risk bonds set aside to meet spending needs in your first few years of retirement.
Are you planning to retire within the next few years? Do you need help creating a retirement Cash Bucket? Is your portfolio prepared to support your retirement spending needs? If you have more than $1 million saved and need help from a wealth manager, the Peak Wealth Planning team can assist. Schedule a call to learn more today.
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About the Author
Peter Newman is a Chartered Financial Advisor (CFA) and president of Peak Wealth Planning. He works with individuals nationwide that have accumulated wealth through company stock, ESOP shares, real estate, or running a business. Peter applies his unique background to help clients achieve their specific goals and enjoy peace of mind.
Peak Wealth Planning provides concierge services to meet your wealth management needs. Services include: financial planning, investment management, esop diversification, retirement income, insurance, and estate planning advice. Peak Wealth Planning is a fee-only financial advisor based in Champaign, Illinois, and Fraser, Colorado.