Making Your Money Last

The Biggest Risk Retirees Face Right Now

Those nearing retirement and those who have recently become retirees need to plan now for the possibility of a bear market. Here are two ways to do that, including one that goes against conventional wisdom.

Those planning to retire face many risks. There is the risk their money will not earn enough to keep up with inflation, and there is the risk of outliving one’s money, for example. But perhaps, the biggest risk retirees face now is more immediate: Retiring in a bear market.

To put this in perspective, First Trust, an asset manager, analyzed the history of bull and bear markets from 1926-2017 and found bull markets — which are up or positive markets — lasted on average nine years. If that is the case, this bull market should be ending right about now, as it just turned 9 on March 9, 2018. Consider also the study found that the typical bear market lasts 1.4 years, with an average cumulative loss of 41%.

Not to be all doom and gloom, but the chart below illustrates why the biggest risk retirees face right now is a bear market. It shows what happens to two identical $1 million portfolios, depending on the timing of bad stock market years.

AgeMarket
gain/loss
Mrs. Jones
Portfolio value
Market
gain/loss
Mr. Smith
Portfolio value
Annual
Withdrawal*
660.22$1,160,000-0.07$870,000$60,000
670.151,272,200-0.04773,40061,800
680.121,361,2100.12802,55463,654
69-0.041,241,1980.15857,37365,564
70-0.071,086,7840.22978,46567,531
710.221,256,320-0.07840,41669,556
720.151,373,124-0.04735,15671,643
730.121,464,1070.12749,58373,792
74-0.041,329,5360.15786,01476,006
75-0.071,158,1820.22880,65178,286
760.221,332,348-0.07738,37080,635
770.151,449,146-0.04625,78183,054
780.121,537,4970.12615,32985,546
79-0.041,387,8860.15619,51788,112
80-0.071,199,9780.22665,05590,755
810.221,370,495-0.07525,02393,478
820.151,479,787-0.04407,74096,282
830.121,558,1910.12357,49899,171
84-0.041,393,7170.15308,976102,146
85-0.071,190,9470.22271,741105,210
860.221,344,588-0.07144,352108,367
870.151,434,659-0.0426,960111,618
880.121,491,852  114,966
89-0.041,313,762  118,415
90-0.071,099,831  121,968

* Adjusted for 3% inflation

Mr. Smith and Mrs. Jones start off with the same $1 million portfolio and make the same annual $60,000 annual withdrawal (adjusted for 3% inflation after the first year). Both experience the same hypothetical returns, but in a different sequence. The difference is the timing. Mrs. Jones enjoys the tailwind of a good market, whereas Mr. Smith’s returns are negative for the first two years.

The impact of increasing withdrawals coupled with poor returns is devasting to Mr. Smith’s long-term performance. In the end, Mrs. Jones has a healthy balance left over, whereas Mr. Smith runs out of money after age 87.

With stock market valuations higher and this bull market overdue, by historical averages, retirees today could be faced with low to poor returns much like Mr. Smith in the first few years of retirement. However, retirees like Mr. Smith still need stocks to help their portfolios grow over time and keep up with the rising costs of living. Unfortunately, no one knows for sure what the equity returns will be in the next year or the year after.

This is the dilemma many retirees face. The point is to be aware of the sequence of return risk, illustrated in the chart above, and take steps now if retirement is in the immediate future.

Here are two of the many planning possibilities retirees today can use to avoid the fate of Mr. Smith:

1. Use a “glide path” for your withdrawals

In a study in the Journal of Financial Planning, Professor Wade Pfau and Michael Kitces make a compelling argument to own more bonds in the first year of retirement, and then gradually increase the allocation to stocks over time. According to the authors’ work, “A portfolio that starts at 30% in equities and finishes at 60% performs better than a portfolio that starts and finishes at 60% equities. A steady or rising glide path provides superior results compared to starting at 60% equities and declining to 30% over time.”

The glidepath strategy flies in the face of conventional wisdom, which says people should stay balanced and gradually conservatize a portfolio later in retirement.

The glidepath strategy is a like a wait-and-see approach: If the stock market craters in the first year of retirement, be glad you were more in bonds. Personally, I would only recommend this strategy to conservative or anxious clients. My concern is what if markets go up as you are slowly increasing your stock exposure — an investor like this could be buying into higher stock prices, which could diminish future returns. An alternative would be to hold enough in cash so one does not need to sell stocks in a down year per se.

Though not for everyone, the glide path approach has its merits: Namely not owning too much in equities if there is a bear market early on in retirement, which coupled with annual withdraws, could wreak havoc on a portfolio like Mr. Smith’s.

2. All hands on deck

The second planning advice for Mr. Smith is to make sure to use all the retirement income tools that are available. For instance, if instead of taking money out of a portfolio that is down for the year, Mr. Smith can withdraw money from his whole life insurance policy in that year, so he doesn’t have to sell his stocks at a loss. This approach will leave his equities alone and give his stocks a chance to hopefully recover in the next rebound.

The key is proper planning ahead of time.

The bottom line

Retirees today face one of the biggest conundrums — how much to own in stocks? With the average retirement lasting 18 years, and health care costs expected to increase by 6%-7% this year, retirees for the most part can ill afford to give up on stocks and the potential growth they can provide. The problem is the current bull market is reaching its maturity by historical standards, and investors who plan on retiring and withdrawing money from their portfolio in the next year or two may be setting themselves up for disaster if this market craters. Just ask Mr. Smith.

There are many ways to combat a sequence of poor returns, including holding enough cash to weather the storm, investing more conservatively in the early years of retirement via a “glide-path” asset allocation, or using alternative income sources so one doesn’t have to sell stocks in a bad market.

The point is to be mindful of the risk and plan accordingly.

About the Author

Michael Aloi, CFP®

CFP®, Summit Financial, LLC

Michael Aloi is a CERTIFIED FINANCIAL PLANNER™ Practitioner and Accredited Wealth Management Advisor℠ with Summit Financial, LLC.  With 17 years of experience, Michael specializes in working with executives, professionals and retirees. Since he joined Summit Financial, LLC, Michael has built a process that emphasizes the integration of various facets of financial planning. Supported by a team of in-house estate and income tax specialists, Michael offers his clients coordinated solutions to scattered problems.

Investment advisory and financial planning services are offered through Summit Financial, LLC, an SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973-285-3666. This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with their independent tax or legal advisers. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. The Summit financial planning design team admitted attorneys and/or CPAs, who act exclusively in a non-representative capacity with respect to Summit’s clients. Neither they nor Summit provide tax or legal advice to clients.  Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local taxes.

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