The transition into retirement can be nerve-wracking. Often, it means leaving behind a steady paycheck and the security that comes with it. This transition can be even more difficult when the value of your retirement assets has been impacted by swings in the stock market.
Those that make good decisions at the start of their retirement can set the tone for the remainder of their golden years. Conversely, mistakes in the first few years of retirement can completely derail your financial plan. In a bear market, it is all too easy to make these mistakes, but with discipline, you can avoid common missteps and ensure your retirement assets last a lifetime.
Retiring in A Bear Market Comes with Added Risk
A bear market occurs when asset values fall more than 20% from a recent high. Although this is a somewhat arbitrary measure, it’s the standard in the financial world because it generally means markets are in a lengthy down trend. This type of market can pose a significant risk to your future investment returns, because taking a loss early in retirement can be tough to overcome.
To illustrate this, consider the following graph. The data displayed shows the performance of a $1 million portfolio from 1999 to 2018 with 4% inflation-adjusted withdrawals. The red line shows a portfolio invested entirely in stocks. As you can see, when the stock market tumbles during the early years of retirement, it can take years to recover the loss. Conversely, a defensive portfolio may provide a greater level of protection against swings in the stock market. These portfolios are represented by the yellow line with 0% stocks and the blue line with 50% stocks.
Why Did a Defensive Portfolio Perform Better in This Scenario?
A defensive portfolio generally contains a higher concentration of bonds and other income producing assets. Bonds provide a steady stream of income that is not impacted by market conditions. In addition, bond prices generally have a negative correlation with stock prices. As such, a diversified portfolio containing both stocks and bonds may provide some insulation from swings in the stock market while maintaining growth opportunities.
A Bear Market Can Impact Your Required Rate of Return
When you are preparing to retire, your financial advisor should work with you to determine your Required Rate of Return [RRoR™]. This is the rate that your investments need to earn to bridge the gap between your retirement expenses and your guaranteed sources of income like Social Security.
Your RRoR™ is based on the value of your account at retirement. For example, if you have $1 million in retirement assets and need to generate $40,000 per year to meet your expenses, your RRoR™ is 4%. However, if the value of your account declined to $800,000 at retirement, you would need to generate 5% – which may be unattainable during a market downturn.
Preserving Principal is Critical in the Early Years of Retirement – Especially in a Bear Market
Spending a portion of your principal means fewer assets to generate income in the future – resulting in a growing RRoR™. If your expected returns are 4% per year, a $1 million portfolio would generate $40,000 per year while an $800,000 portfolio would only generate $32,000. While most investors wouldn’t spend an extra $200,000 in the first year of their retirement, small withdrawals can add up over the years and reduce your future cash flows. As the income you generate from investments declines, you may need to draw more and more from your principal, creating a cycle that can derail your plans for a comfortable retirement.
In a bear market, it’s critical to preserve your principal during the early years of your retirement. That’s because when you sell while asset values are down, you prevent your shares from having a chance to recover as markets improve. In other words, if you sell shares during a down period you not only reduce your principal by the amount of your withdrawal, but you prevent your shares from recouping the losses.
Solutions for Preserving Your Principal When Retiring in a Bear Market
Preserving your principal early in retirement can be the key to long lasting investment income. However, this can be a difficult task to accomplish during a bear market when your investment returns may not be enough to cover your RRoR™. Consider the following solutions for preserving your principal in a bear market.
Shift Your Allocation from Growth to Income as You Near Retirement
As previously stated, some types of assets, like bonds, provide income that is guaranteed despite changes in asset values. Investing in these types of assets can help you achieve the required income while minimizing the need to sell your investments for cashflow.
Reduce Portfolio Risk
Diversification is a common method for reducing portfolio risk. This strategy involves investing in a variety of assets that move in opposite directions as conditions change. Therefore, when the value of one type of asset falls, the others in your portfolio could hold their value or even increase. By implementing greater diversification in your portfolio, you could mitigate some of the risk associated with the stock market and reduce the impact of a bear market.
Tighten Your Budget
If you can reduce your expenses in the early years of your retirement, it can benefit you in the long run. Spending less translates to lower withdrawals from your retirement accounts and prevents you from needing to access your principal during a market downturn. This is often the simplest way to extend your retirement savings.
Retire Later
If all else fails, you may want to consider delaying your retirement. If you continue to work, you are less likely to need to access your investments while the markets are down.
Prepare for Retirement in a Bear Market with Financial Fingerprint™ by Meld Financial
Retiring can be a scary transition, and even more frightening in a bear market. That’s why you need a trustworthy team of professionals to help you every step of the way. At Meld Financial, our team of tax, legal, and investment professionals have spent more than 40 years helping our clients achieve the retirement of their dreams.
Through our decades of experience, we created a proprietary wealth management platform – Financial Fingerprint™. This comprehensive plan is quick to assemble, easy to understand, and simple to modify as market conditions change. With Financial Fingerprint™, you can calculate your RRoR™, build a comfortable withdrawal strategy, and maintain a portfolio designed to help you achieve your retirement goals in any market condition.
To get started, contact us today.
