When dealing with nervous retirees during a market crash, financial planners don’t start with a focus on how far the market will fall. Good thing, too, because when the impetus behind the rout is a new disease it’s impossible to determine.
Instead, to make sure clients will be OK, advisors ask: How will you pay the bills if you are losing money in the stock market?
Retirees and near-retirees are in a complicated position because they typically must pull money out of their lifetime savings to help pay the bills on a regular basis. Pulling money from stocks amid a bear-market decline of 20% or more depresses overall returns and can set a person up to exhaust their savings too early in retirement.
So while analysts debate where the bear market will bottom during the panicked selling over the coronavirus and oil price war, financial planners offer a plan to prepare for whatever the markets deliver.
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If bills can be covered for three to five years, the common advice is: Stick with a diversified portfolio of stocks, bonds and cash, and don’t sell any stocks until they have healed.
The analysis starts with calculating essential annual spending, and then making sure retirees can tap money market funds, savings accounts, certificates of deposit, dividends, and safe bonds such as U.S. Treasuries or high-quality municipal bonds to cover spending.
If a retiree won’t be able to pay near-term expenses without tapping stocks during a bear market, Charles Farrell, chief executive of Northstar Investment Advisors in Denver, said he would suggest a retiree reduce spending rather than selling stocks. But if that wouldn’t be possible and the retiree didn’t have cash reserves to cover upcoming bills, he said he would reallocate some money from stocks into cash and bonds now to cover six months to a year.
“Do it instead of hoping” for a rebound, Farrell said. “The key is to avoid disaster … It could trend down 30% or 35%.”
Historically, bear markets last an average of 19 months and the median time to recover from losses has been two years and three months, according to the Leuthold Group. Still, recoveries vary greatly. The longest time to recovery since the Great Depression was 7.5 years after the 48% decline in the 1973-74 bear market.
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Although stocks have plunged more than 20% in less than a month, many people haven’t suffered as much as they assume, said Maria Bruno, head of U.S. Wealth Planning Research for Vanguard Group. Taking a look at your overall retirement savings can help allay fear, she said, despite the inclination of many to avoid looking at their investment accounts.
In bear markets, bonds usually buffer people from the full fury of the market. That’s why advisors typically insist on bonds in a portfolio even when bonds are paying little interest. For instance, Vanguard’s target-date funds use a 50/50 stock-bond allocation for a 65-year-old and then slowly move into more bonds and less stocks as the investor ages. By age 72, only 30% remains invested in stocks and that allocation is retained through retirement, said Bruno.
So say you had $1 million in a S&P 500 index fund on Feb. 19, when investors started to fixate on the economic damage the virus could cause. After a sharp decline through March 12, only $737,187 would have remained.
It was an ugly decline, but not nearly as ugly if you had a 50/50 mix of stock and bonds that is a common formula for people early in retirement. In that scenario, if you had a $1 million retirement portfolio half in the S&P 500 (.SPX) and half in the Barclays Aggregate Bond Index, the portfolio would have had $873,225, according to Morningstar.
Contrarian advice: Take a look at your statements
When a person is determined to sell stocks or exchange-traded funds, financial advisers suggest trying to sell on a day when stocks are rallying rather than plunging amid a panic.
If the idea is to stockpile cash, the safest place would be in a Federal Deposit Insurance Corp.-insured bank account or an National Credit Union Administration-insured credit union. Up to $250,000 would be insured if a financial institution were to fail. Recently, high-yield savings accounts at a few FDIC-insured online banks were paying as much as 1.7%. You won’t find that at most banks or brokerage accounts.
When selling a stock or exchange-traded fund, beware of simply entering a market order. That type of sale essentially says to “sell now at whatever price.” In a fast-falling market, your trade may not be executed until a much deeper decline has occurred. To protect yourself, sell with a “limit order.” That type of order specifies to your broker the price to sell.
Another thing to be aware of: If you get nervous during a selloff and want to bail out of a mutual fund to stop the losses in the middle of the day, don’t. That’s because it doesn’t matter when you sell mutual-fund shares during the day; the price you get is calculated at the end of the trading day at 4 p.m. Eastern time. So while you might flee in the morning, the end-of-day price could be a lot lower than the price where you decided to sell.
Safe selling
Financial advisors want people to consistently hold bonds because they typically act like insurance when bear markets maul stocks. Generally, when stocks are plunging investors seek safety in bonds, so bonds climb in price while stocks inflict losses.
That assumes that the bonds are safe bonds such as U.S. Treasuries. High-yield, or junk, bonds typically fall along with stocks in a bear market—and that is playing out now. The losses in high yield may be startling to retirees who increasingly have been pushed into higher-risk bonds by advisors the past couple of years because Treasuries were paying so little interest.
A look at returns during the past month demonstrates why trying to boost income with high-yields bonds can undermine the role of bonds as portfolio insurance. The iShares $ High Yield Corporate Bond ETF (HYG) fund has declined 8.3 % during the past month compared to the 10% gain in the SPDR Portfolio Long Term Treasury ETF (SPTL).
James Lee, a Saratoga Springs, N.Y., financial planner says this demonstrates why it’s important to hold safe bonds even when they’re yielding little. And that’s a useful reminder as the coronavirus keeps stock investors on edge.
Know your bonds
Defending your savings amid market chaos
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How to limit the impact on your portfolio if you're in
or near retirement.
