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Key Implications of Retiring in a Bear Market
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The Worst Time to Lose Money.
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There is never a good time to lose money. However, a 2008 study for financial services giant MetLife, conducted by retirement income professionals, demonstrated that the years immediately prior to and after retirement are, undoubtedly, the worst time to lose money.
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The study showed that bear market investment returns during retirement, even in just one year, have such a substantial impact that a portfolio runs out of money faster. Just how fast depends upon your age when it occurs. A minus 20 percent return during the first year of retirement shortened the life of the portfolio cited in the study by approximately eight years. The same negative return occurring in retirement's ninth year depleted the portfolio about four years earlier.
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The key insight? While it never feels good to lose money, when you are retired, the older you are when a bear market occurs, the better.
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How You Earn Returns Matters.
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The same study explored a slightly different implication. It looked at two sample portfolios where everything—starting balance, investments used, dollar amount withdrawn per year, and more—was the same except the order in which annual investment returns occurred.
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The first portfolio earned 17 percent the first year, a minus 20 percent the second, and then 27 percent in the third year. It continued earning those same returns in three-year cycles forever. In the second portfolio, the researchers simply rearranged the order, earning 27 percent in the first year, 17 percent the second, and a minus 20 percent in the third year, repeating in three-year cycles forever.
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What the researchers found was striking. The first portfolio fizzled out nearly two years ahead of schedule, while the second portfolio lasted about six years longer. Bear market returns can be difficult, if not impossible, for a portfolio to recover from.
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Here are 5 things you can do now to be prepared for any market
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1) Take Control by Creating a Plan.
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When it comes to building your retirement, focus on what you can control, which is generally how much you save, how conservative or aggressive you are, the amount you need each year to fund your retirement, and the age at which you retire.
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Equally important is what you can't control. You don't get a say over whether the markets will be bullish or bearish, or to what age you'll live. A good plan helps you maximize what's in your control and appropriately manage risk for what isn't.
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2) Be Open to Working Longer.
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If you're fortunate enough to be fit for work, be open to the idea. Don't think you have to do the job you've always done. Consider part-time opportunities. The extra year or two you spend working may translate into thousands of dollars per year in retirement income later because you didn't have to tap into as much of your assets initially.
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For example, one client works in the garden department at a big-box retailer. He sees it as stress relief because he enjoys helping people with their yard projects. On top of that, he makes some extra cash. Financially, it means that he doesn't have to tap into some of his retirement assets until later.
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3) Diversify.
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Diversification—spreading your money across a wide variety of asset classes—is one way to manage risk. Your 401(k) plan likely provides traditional ways to do this by offering investments that are large cap, small cap, and so on. However, opportunities beyond the traditional array can complement the bigger picture and further reduce risk.
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Some alternatives include real estate investment trusts, commodities, long-short funds, and managed futures. All of these are more dynamic money management tools than typical buy and hold options. You may only be able to find these options in your 401(k)'s okerage window, which can ing the full market to your fingertips right inside your plan. If your plan doesn't offer one, you could always go outside and augment your approach with a traditional IRA or a standard okerage account.
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4) Recognize the Value of Help.
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Only you can assess whether you are effective at managing your financial picture. From setting goals to implementing your plan, there are good options for getting help. And according to a 2011 study conducted by investment advice firm Financial Engines and employee benefits consultancy AON Hewitt, help can make a difference.
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The study compared the investment performance of 401(k) plan participants using one of three types of help—investment advice, target date funds or managed accounts—to the performance of those not using help. The difference was noticeable. The average annual median return of those using help was nearly three percent higher, net of fees, than those not using help.
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Now that you know how a bear market can impact your retirement savings and what you can do about it, take action to be ready for the inevitable market cycle. When it comes to your money, repeat after me, “Protect first. Grow second.”
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5) Take Some of the Risk Off the Table.
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One way to take some market risk off the table is to transfer it to an insurance company through an annuity. The use of annuities has been on the rise, partly due to new features that have improved their once clunky past reputation. While they don't make sense for everyone, they can serve to reduce risk for some.
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Gregory Ostrowski is a CFO with Scarborough Capital Management, an Annapolis-based firm providing comprehensive financial advisory services.
