mdphoto16 | E+ | fake images
It’s a scary time for new retirees.
Stocks have plummeted this year. Bonds, which traditionally serve as a drag when stocks falter, have also been hit. Both of these trends are concerning for seniors who rely on investments for their retirement. High inflation also means retirees need to earn more income to pay for the same items and make ends meet.
“That’s a pretty bad mix that’s relatively rare,” David Blanchett, head of retirement research at PGIM, the investment management arm of Prudential Financial, said of this triple challenge.
More on Personal Finance:
Tax breaks are not the main reason for high net worth philanthropy
Only 18% plan to increase investments in stocks this year
Buyers are making concessions to get a house
“2022 has been a dangerous time to retire,” he added.
However, there are steps retirees, and those planning to retire soon, can take to protect their savings.
why does it matter
The S&P 500 Index is down almost 17% in 2022. The index fell into a bear market at one point on Friday (meaning the US stock index fell more than 20% from its recent high in January) before recovering a bit.
The Bloomberg US Aggregate Bond Index is also down more than 9% this year. Bond prices move against interest rates, a dynamic that has stressed bond funds as the Federal Reserve raises its benchmark rate.
Investors are most vulnerable to market shocks in the early months and years of retirement.
This is due to “return sequence” risk. Someone who withdraws money before retirement from a portfolio that is declining in value is at greater risk of depleting their savings too soon, compared to a retiree who experiences a market downturn years later.
When the market goes down, it means that investors need to sell more of their investments to generate income. That depletes savings faster and leaves less room for growth when things pick up, hampering a portfolio meant to last decades.
The “sequence”—or timing—of investment returns is what matters.
Consider this example from Charles Schwab of two new retirees with portfolios of $1 million and annual withdrawals of $50,000 (adjusted for inflation). The only difference is when each experiences a 15% portfolio loss:
One has a 15% decline in the first two years of retirement and a 6% gain each year thereafter. The other has a 6% annual return for the first nine years, a negative 15% return in years 10 and 11, and a 6% annual return thereafter.
The first investor would run out of money after 18 years, while the other would have about $400,000 left.
“If you’re planning for 30 years [of retirement]those early years could be really important in terms of what you end up experiencing for your outcome,” Blanchett said.
Of course, some retirees are more vulnerable than others.
For example, a retiree who gets all or most of their income from Social Security, pensions, or annuities is largely unaffected by what happens in the stock market. The amount of those funds is guaranteed.
Also, the risk of sequence of returns is probably less consequential for someone retiring at an older age, because their portfolio won’t have to last as long. Nor is it likely to affect a retiree who has saved much more money than is necessary to finance her lifestyle.
If new retirees are nervous about the current market situation, there are a few ways they can reduce their risk.
On the one hand, they can reduce spending, thereby reducing withdrawals from their savings. A follower of the “4% rule” strategy might choose to forego an adjustment for inflation, for example, even though there are many different schools of thought regarding spending in retirement.
Whatever the strategy, reducing withdrawals puts less pressure on the investment portfolio.
“Does that mean you can’t go on a fun cruise or a vacation? Not necessarily,” Blanchett said. “It requires more thinking about trade-offs, potentially, based on how things are going.”
Similarly, retirees can restructure where their withdrawals come from. For example, to avoid taking money out of stocks or bonds (categories that are in the red this year), retirees can take out cash.
This goes back to sequence risk and tries not to take money out of assets that have gone down in value. Drawing from a bucket of cash while waiting for other assets to (hopefully) recover helps to achieve this.
“You don’t want to sell stocks or bonds in this environment if you can afford not to,” said Christine Benz, director of personal finance at Morningstar.
However, retirees may not have several months or years of cash on hand. In this case, they can withdraw from areas that have not been as affected as others, for example, perhaps from short- or medium-term bond funds, which are less sensitive to rising interest rates.
Workers who have not yet retired (and who are worried about having enough money to do so) can choose to work a little more, to the best of their ability. Or, they may think about earning some extra income after they retire to put less pressure on their savings.
Reducing the demands on your investment portfolio is one of the most important things you can do, Benz said. For example, Social Security beneficiaries get a guaranteed 8% annual increase in their benefits for each year they delay filing after full retirement age. (However, that 8% increase stops after age 70.) Seniors who can delay get a permanent increase in their guaranteed annual income.