Tips for Managing Retirement in a Financial Downturn
Most Americans fund their retirement with some confidence: investing will help their savings keep pace with inflation, institutions will continue to function as they always have, and everything will work out eventually.
It’s hard to sustain that optimism at times like these, when it seems like everything is in the balance and nothing is certain. You could call the American approach to the game retired, and you wouldn’t be wrong.
Of course, the future has always been uncertain. He was unknowable in 1973, during one of the highest periods of inflation; in 2000, when the Internet bubble burst; and again in 2008, when the real estate and financial markets collapsed. And that’s opaque now, as markets are down around 11.6% year-to-date as inflation remains high, at 8.5% in July, although it has slowed slightly compared to the previous month. Bonds generally provide some cushion when stocks fall, but they haven’t provided much cushion either.
“This year has been disconcerting for retirees as it has been a triple whammy – falling stock prices, falling bond prices and high inflation,” said Christine Benz, director of personal finance and retirement planning. at Morningstar.
Unlike young workers, retirees do not have the luxury of waiting. Timing matters. Market declines that occur during the first five years of retirement can cause significant and permanent damage, making it more likely to deplete a portfolio, largely because there is less money left untouched for the (possible) recovery of the market. It is less risky to suffer such a drop later in retirement simply because the money no longer has to last as long.
T. Rowe Price recently looked back over the past half-century to see how people who retired in different recessions fared even in times of high inflation. The good news: their portfolios have done well, or should. The worst: Past performance is not indicative of future results.
The company’s research is rooted in the widely known 4% rule of thumb, which found that retirees who withdrew 4% of their retirement portfolio balance in the first year and then adjusted that dollar amount for inflation each year after, created a paycheck that lasted 30 years.
Using this framework, T. Rowe Price analyzed how investors with a $500,000 portfolio – 60% stocks and 40% bonds – would fare over 30 years if they had retired at the beginning of the year in 1973, 2000 and 2008. (The last two periods are still in progress.) They would all start withdrawing $1,667 each month – or $20,000 per year – and then increase this amount each year based on the actual inflation rate of the previous year.
Let’s go back to 1973, which, given the oil embargo and high inflation rates, echoes the present. Retirees should then have seen their portfolios shrink to $328,000, or almost 35%, by September 1974, and inflation rise by more than 12% by the end of the same year, according to the analysis. An incredibly painful one-two.
Retirees had no idea at the time that circumstances would change, but less than a decade after retirement, the portfolio balance had once again reached $500,000. And even after the downturn of 2000, after 30 years, the portfolio had grown to over $1 million.
“It’s all kind of a pin to start with this 4% withdrawal rate,” said Judith Ward, senior financial planner and director of thought leadership at T. Rowe Price.
She conceded that retirees don’t spend in a straight line and tend to spend earlier in retirement. But the study, she said, underscores the importance of starting with a prudent spending plan when a portfolio is down. “That lever of how much you spend is really a powerful lever that works,” she added.
Using the same approach with those who retired in more recent bear markets – in the periods after 2000 and 2008, when the stock market lost about half of its value – the portfolios also had to be sustainable, even if the retirees still have about eight and 14 years before reaching 30 years of retirement. (Ward’s findings also hold for other scenarios, including one in which inflation persists at 9% for the remainder of the 30-year retirement periods.)
“These scenarios assume the investor has not adjusted their behavior due to the inevitable anxious market loss likely caused,” Ms. Ward said. “It’s human nature to adapt and adjust, and retirees will likely want to alter their plans in some way.” This adds an even stronger margin of safety, she said.
Other experts warn retirees not to rely too much on past results because the future is always uncertain! – may have something else in store.
“Using the past gives false confidence,” said David Blanchett, head of retirement research at PGIM, the asset management firm part of Prudential Financial. “The United States and Australia have had two of the best capital markets in the past 100 years. It is useful, but we must look forward.
That’s why financial experts suggest taking a flexible approach to withdrawals, focusing on what you can control at the time when conditions change.
Here are some strategies that can help you.
Cropping. One approach is to think of your withdrawals in terms of needs, wants, and wishes. How much of your basic needs are covered by predictable sources of income like social security or pensions, and how much more do you need to withdraw to cover the rest? Maybe the withdrawal rate to cover your basic needs is 3-4%, but your needs could be somewhere between 4-6%. “The most important thing is that your needs are covered,” Blanchett said.
A bucket of money. The big idea here is to keep at least a year’s worth of basic expenses — not covered by predictable sources of income, like Social Security — in cash or something equivalent, so retirees in crisis can spend out of that. bucket instead of having to touch their wallet, giving him more time to recover.
This approach takes some planning, but it can ease the anxiety of retirees who find solace in siloing. Critics have said that keeping a significant amount of a portfolio in cash can be a drag, hurting long-term returns, but for many retirees it can provide a plan they can stick to — and this is the most important factor.
Bodyguard. The strategy, pioneered by financial planner Jonathan Guyton and computer scientist William Klinger, encourages retirees to be flexible, increasing their withdrawals when the market is doing well and shrinking when it’s not.
Their research found that retirees are generally safe starting with a withdrawal rate of around 5% for the first year (and then adjusting that amount each year for inflation) – as long as they reduce their spending. when they receive a warning signal.
This light starts flashing when the removal rate increases by a certain amount – or one-fifth – above its initial rate. So if the portfolio collapses and the amount withdrawn now translates to 6% or more, compared to 5% before, retirees should reduce their withdrawal amount by 10%.
For example, consider a retiree who in the first year receives 5%, or $25,000, of a $500,000 portfolio. If inflation were 9%, the next year’s withdrawal would normally be $27,250. But if a guardrail were triggered – that is, if the portfolio dropped to around $415,000, which now equals $25,000 at a 6% withdrawal rate – the amount withdrawn should instead drop to $24,525 (or 10% less than $27,250).
Conversely, if the portfolio grows, resulting in a reduction in the withdrawal rate to 4%, the retiree can increase the amount withdrawn by 10% and then adjust for inflation.
This rule is generally applied until the last 15 years of retirement – for example, an 85-year-old couple who want to be secure until age 100 can stop using it, as long as they don’t care how much of money that he wants to leave to their heirs.
Verification. This is another rough rule that helps retirees determine if they are withdrawing too much.
Let’s say you retire at age 70 and decide you’ll probably need your money until age 95. Divide one by 25 (the number of years you need the money): this translates to a withdrawal rate of 4% for that period. year. With a $500,000 portfolio, that’s $20,000.
But if you’re on track to withdraw $30,000 that year, or 6%, you might want to withdraw. “It’s a gut check in progress,” Mr. Blanchett said. “Is this going to work in the long term? And it’s a very easy way to get an answer.
What if you don’t adapt? Just understand that you may need to make more drastic changes later.
“You just exchange money with yourself over time,” Blanchett added.