Like it or not, many retirees depend on the stock market to cover some of their financial needs.
When the market becomes volatile, as it has amid fear of the coronavirus epidemic, many get nervous.
“Watching 10% of a stock portfolio disappear in a week is jarring,” said Wade Pfau, a professor at the American College of Financial Services in King of Prussia, PA.
For people who are years from retirement, there is no reason to make changes to a long-term financial plan. But for those in or near retirement, such market moves can be a wake-up call to put “a strategy in place to make sure it doesn’t derail your retirement,” Mr. Pfau said.
It’s important to understand the trade-offs, but there are steps you can take to limit the impact of selling stocks when they are down, and partly protect
your portfolio.
Check in with your accounts
If the market has you spooked, consider whether you have saved enough.
Start by estimating your annual spending in retirement. A couple who wants $90,000 in gross income and is entitled to $50,000 a year in Social Security, for example, needs $40,000 from savings.
Multiply that number by 25. The result—or $1 million—is what the couple would have to save to withdraw $40,000 a year from a portfolio with 50% to 75% in stocks without violating the 4% rule.
That rule says you can spend 4% in the first year of retirement and give yourself an annual raise over the next 30 years for inflation without running a big risk of going broke. Given today’s low interest rates, Mr. Pfau believes the safe withdrawal rate is around 3%. That means the couple above would need to save more than $1.3 million.
“You need to decide how much conservatism you want to bake into your approach.”
Wade Pfau, American College
of Financial Services
_
People entering retirement often have a significant portion of savings—say, 40% to 60%—in stocks to keep their nest egg growing. As they age, most gradually reduce stock exposure to protect against market declines.
But a study by authors including Mr. Pfau finds that those who reduce stock exposure in the initial years of retirement—to 20% to 30%—and then gradually raise it over time—to 50% to 70%—are likely to make their money last 30 years even in the worst market scenarios.
In contrast, those who taper over retirement to 30% in stocks from 60% are likely to run out of money after 28 years in the 5% of worst-case scenarios, says Mr. Pfau.
The new approach provides better downside protection in the years right after retirement, when retirees are most vulnerable to losses. If a bear market occurs then, a portfolio can be depleted by market losses and withdrawals.
Of course, if stocks fare well in the early years, the conventional approach will come out ahead.
Go more conservative
If you are worried you may not have enough, consider postponing retirement or returning to work, even part time.
According to T. Rowe Price Group Inc., a 62-year-old with a $100,000 salary and a $500,000 nest egg who earns a 6% annual return could see his annual retirement income from investments and Social Security rise by 6% to 7% for every year he remains in the workforce, even if he saves nothing additional.
Working longer allows a person to delay tapping retirement savings and reduces the number of years in retirement. For every year in which someone puts off taking Social Security between ages 62 and 70, benefit checks rise by about 7% to 8% after inflation.
Work longer
In contrast to the 4% rule, strategies that reduce spending when markets stumble can help retirees better manage the risks of a bear market, said Mr. Guyton, co-author of one such approach.
Say you retire with $1 million, 60% in stocks and 40% in bonds, and withdraw 5%, or $50,000. At year-end, the method calls for recalculating the withdrawal amount, using your new balance. Assuming your portfolio declines to $800,000, the $50,000 withdrawal—plus an annual inflation adjustment—now represents more than 6.2% of the $800,000 balance.
Cut spending
Some recommend setting aside one to five years of living expenses in cash so as not to have to sell stocks at depressed prices. But low returns on cash raise the risk of depleting the nest egg, said Mr. Pfau.
A better strategy is to use winners after major market moves to cover expenses. For example, in 2008, when the S&P 500 lost about 37%, investment-grade bonds gained about 5%. Someone with 60%, or $600,000, in stocks and 40%, or $400,000, in bonds before the crash had 47%, or $378,000, in stocks and 53%, or $420,000, in bonds afterward.
If a retiree with such a portfolio needed $40,000, he would withdraw the $20,000 of bond profits. Because bonds comprise substantially more than 40% of the postcrash portfolio, the investor would take the additional $20,000 he needs from bonds as well. To re-establish the desired 60%-40% allocation, he would then transfer about $77,000 more to stocks from bonds.
By shifting money into beaten-down assets, rebalancing helps a portfolio recover faster amid a turnaround, Mr. Pfau said.
Spend from winners
Any time your withdrawal rate exceeds 6%, the rule imposes a 10% withdrawal cut for the next year, says Mr. Guyton. After adjusting the $50,000—to $51,000, assuming 2% inflation—the person should cut spending by 10%, or $5,100, producing a second-year withdrawal of $45,900.
In years in which the withdrawal rate is between 4% and 6%, simply adjust your most recent withdrawal for inflation. When the withdrawal rate falls below 4%, you can take a 10% raise.
“If you are managing your own allocations, the key to surviving market turmoil is to have a long-term plan and stick with it.”
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© 2020 Bloomberg. These presentations are provided for informational purposes only.
Financial adviser Jonathan Guyton argues the couple can spend 5% of an $800,000 nest egg, provided they can cut spending in years after markets fall.
“You need to decide how much conservatism you want to bake into your approach,” said Mr. Pfau. People who cannot stomach the stock market will need to save even more in bonds, due to today’s low interest rates.
- Bankrate.com
- Reuters