When a Bear Market Interrupts Your Plans for Retirement
You may have seen it before. Perhaps it was a colleague, 12 years ago, who was planning to retire at the end of the year. Then it happened: stock market values collapsed and your colleague’s retirement plans were put on hold. It’s a common story, and it has been repeated throughout the decades and throughout market cycles. It will happen again at some point in the future.
As a financial planner, one of the most important things I do is help clients look at alternate scenarios. These include scenarios we hope will never occur, but we want to make sure their nest egg can handle the shock, in the event they do. In the case of a shock like the effect on the markets due to the pandemic, we work with clients to figure out how the real and present impacts of the COVID-19 crisis affect the outlook for an upcoming or recent retirement.
Let’s look at the numbers, to get perspective on the relative impact that the recent market decline of over 30% would have on a typical retirement plan. This will be a generic exercise; your experience and situation may differ.
For this exercise, we will use the following assumptions for the client:
- Retirement is planned for end of 2020
- Retirement age is 66
- Anticipated living expenses net of taxes is $125,000/year in retirement until age 80 when it drops to $100,000/year in today’s dollars
- Taxable investments of $500,000
- Retirement investments of $1,500,000
- Current year loss of 30% market value.
- Investments are allocated as follows: Balanced portfolio (60% stocks/40% bonds) with a conservative average annual return of 5.3%.
Without the market downturn, this household was in a good position to retire. Their likelihood of success calculated by a Monte Carlo analysis showed that they are in the sweet spot of having a successful retirement, defined as a high probability of not running out of money in retirement or leaving a lot of money after they pass away.
With the market downturn, retirement the year that stocks have dropped 30% in value is very unlikely to end in success without some changes to spending. If the individual is unwilling or unable to delay retirement, their annual spending will have to be reduced and efforts will need to be made to avoid selling equities when their values are down. Just as we measure spending for financial plans during periods of low market volatility, the individual needs to have a good understanding of their fixed and discretionary costs. This allows the individual to identify where they can cut their budget to reduce their spending. (Please see our previous article about identifying real spending, a critical component of successful financial planning) Once equity returns have had time to recover previous losses, the individual can work with their financial planner and investment advisor to calculate how spending can increase and those increases will affect their retirement.
If individuals are unwilling to sacrifice their lifestyle, they need to be able and willing to continue working. Adding additional years of work and delaying the start of social security payments by the same amount of time would likely leave the person in our example in a position to retire with the lifestyle they had previously planned. As previously mentioned, giving the equity markets time to recover will greatly increase the likelihood of success in retirement and avoids selling stocks when their prices are down.
Please note that this is an overly simplified example and every household is different. The purpose of this exercise is to start a conversation within your household of how the recent market downturns may affect your upcoming plans for retirement. The best way to have a sense of confidence in your options is to work with a CERTIFIED FINANCIAL PLANNER™ to review and understand your current situation and your options.
The financial planners at Smith & Howard Wealth Management can work with you to make sound recommendations so that you can be confident in your financial decisions. Our financial planners are salaried and avoid conflicts of interest because our firm only provides fee-based investment management. Our investment officers manage portfolios to use interest income from bonds and dividends from stocks to provide needed cash and work with low volatility assets to bridge the gap while equities recover. They also use periods of market volatility to rebalance assets and identify assets that are undervalued and present attractive buying opportunities.
If you have questions, please reach out to Jeff M. Brandon, CFP® or Michael Mueller, CFP® at Smith & Howard Wealth Management to discuss your situation or to develop a comprehensive financial plan to thoroughly analyze your situation. (Note: this article was updated 4/23/2020)