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It’s a scary time for new retirees.
Stocks have plunged this year. Bonds, which traditionally serve as ballast when stocks falter, also suffered. Both of these trends are worrisome for seniors who rely on investments for their retirement income. High inflation also means retirees need to squeeze in more income to afford the same items and make ends meet.
“It’s a pretty bad combination that’s relatively rare,” David Blanchett, head of retirement research at PGIM, the investment management arm of Prudential Financial, said of the three-pronged challenge.
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“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 nest egg.
why is it important
The S&P 500 index is down nearly 17% in 2022. The index fell into a bear market at some point on Friday (meaning the US stock index is down 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 opposite to interest rates, a dynamic that has strained 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 the “sequence of returns” risk. Someone who withdraws money early in retirement from a declining portfolio is more likely to exhaust their nest egg too soon, compared to a retiree who experiences a market downturn years later.
When the market goes down, it means investors need to sell more of their investments to generate income. This depletes savings faster and leaves less room for growth when things bounce back, hampering a portfolio meant to last for decades.
The “sequence” – or timing – of returns on investment is what is important.
Consider this example from Charles Schwab of two new retirees with $1 million portfolios and annual withdrawals of $50,000 (adjusted for inflation). The only difference is when each suffers a 15% portfolio loss:
One registers a 15% decline in the first two years of retirement and a 6% gain each year thereafter. The other has a 6% annual gain for the first nine years, a negative 15% return in years 10 and 11, and a 6% annual gain thereafter.
The first investor would run out of money after 18 years, while the other would have around $400,000 left over.
“If you’ve been planning for 30 years [of retirement]those early years could be really important in terms of what you end up going through for your outcome,” Blanchett said.
Of course, some retirees are more vulnerable than others.
For example, a retiree who receives all or most income from Social Security, pensions, or annuities is largely unaffected by what happens in the stock market. The amount of these funds is guaranteed.
Also, the risk associated with the sequence of returns is probably less important for someone retiring at a later age, as their portfolio will not need to last as long. Nor is it likely to greatly affect a retiree who has saved far more money than necessary to fund his lifestyle.
What to do
If new retirees are nervous given the current market situation, there are several ways to reduce their risk.
On the one hand, they can reduce their spending, thereby reducing withdrawals from their nest egg. A follower of the “4% rule” strategy might choose to forgo an inflation adjustment, for example – although there are many different schools of thought regarding spending in retirement.
Regardless of the strategy, the reduction in withdrawals puts less stress on the investment portfolio.
“Does that mean you can’t go on a fun cruise or vacation? Not necessarily,” Blanchett said. “It requires thinking more about the trade-offs, potentially, depending on how things go.”
Similarly, retirees can restructure the source of their withdrawals. For example, to avoid withdrawing money from stocks or bonds (categories that are in the red this year), retirees can instead withdraw cash.
This comes down to sequence risk and trying not to make money from assets that are falling in value. Drawing from a bucket of cash while waiting for other assets to recover (hopefully) helps achieve this goal.
“You don’t want to sell stocks or bonds in this environment if you can afford it,” said Christine Benz, director of personal finance at Morningstar.
However, retirees may not have months or years of cash on hand. In this case, they can tap into areas that haven’t been hit as hard as others, for example, perhaps short-term or medium-term bond funds, which are less sensitive to rising rates. of interest.
Workers who have not yet retired (and who are concerned about having enough money to do so) can choose to work a little longer, if possible. Or, they can think about earning a side income once they retire to put less pressure on their nest egg.
Reducing the demands on your investment portfolio is one of the most important things you can do, Benz said. For example, Social Security recipients get a guaranteed 8% annual increase in their benefits each year they delay claiming full retirement age. (This 8% increase stops after age 70, however.) Seniors who can delay get a permanent increase in their guaranteed annual income.