No. 6: Retirement Savings in a Bear Market
One thing that could derail even the best-laid plans of anyone thinking about quitting soon is the potentially devastating impact of retiring in a bear market -- commonly defined as a drop of at least 20% in the value of Standard & Poor's 500-stock index.
One thing that could derail even the best-laid plans of anyone thinking about quitting soon is the potentially devastating impact of retiring in a bear market -- commonly defined as a drop of at least 20% in the value of Standard & Poor's 500-stock index. In July, the S&P 500 slipped into bear territory.
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One widely accepted rule of thumb says that if retirees limit their initial withdrawal to 4% of their investment portfolio -- and then increase that amount by 3% a year to keep pace with inflation -- they have a 90% chance of being able to finance a 30-year retirement. Unfortunately, many pre-retirees aren't familiar with the 4% rule.
In fact, according to a new survey by MetLife's Mature Market Institute, nearly 70% of those who responded thought they could safely withdraw much more -- as much as 10% a year -- without running out of money. At that rate, their funds would actually be depleted in nine years.
In addition, the results of MetLife's 2008 Retirement Income IQ Test show that 60% of preretirees underestimate their life expectancy. (The average 65-year-old man is expected to live until 82, and the average 65-year-old woman until 85, meaning that many Americans will live even longer.)
Poor stock-market performance or outright losses during the first five years of retirement also significantly increase the chances that a retiree will outlive his or her money, says T. Rowe Price's Fahlund. The reason is simple: There will be less money available to invest when the market recovers.
Retirees may instinctively want to flee the risk of stocks in a down market. But new T. Rowe Price research shows that a more effective strategy is to reduce annual withdrawals from your nest egg temporarily, or at the very least keep withdrawal amounts constant, forgoing annual increases until the market rebounds.
T. Rowe Price's analysis uses historical market returns from January 1, 2000, through January 31, 2008 -- a period that includes a deep bear market from 2000 to 2002 and a healthy recovery through 2007. Returns in the remaining 22 years of the 30-year retirement period are projected based on a range of simulated outcomes.
"In this study, the retiree who kept intact an asset allocation of 55% stocks and 45% bonds but reduced withdrawals for a few years did well," says Fahlund. "But investors who panicked and switched to 100% bonds badly hurt their chance of having enough money for retirement by getting out of stocks just as the stock market was poised to recover."
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