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A lasting market downturn can be big risk early in your retirement


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For investors whose retirement is decades away, the stock market’s pullback should be of little concern — there’s plenty of time for your portfolio to recover before you need the money.

But if you’re a retiree, or are nearing retirement, consider what a long-term dip in your portfolio would do to your overall financial picture.

In the beginning years of retirement, it is possible to be exposed to significant risk from down markets. That risk basically is about how the order, or sequence, of stock returns over time — combined with your portfolio withdrawals — can impact your balance down the road.

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Wade Pfau of the American College of Financial Services, who is an expert on retirement income, said that if there’s a downturn too early, it could derail your entire retirement plan.

It has been a difficult week for major indexes. Through Thursday’s close, the S&P 500 index has shed 3.9%, the Dow Jones industrial averageIt is down approximately 3.4% Nasdaq composite indexIt has fallen 4.9%. Year to date, the S&P has lost 5.9%, and the Dow and Nasdaq have dropped 4.4% and 9.5%, respectively.

Investors can generally buy stocks at lower prices in down markets.

This also means that you may be selling at a lower price if your property is sold. This can prove problematic for retired people.

Avani Ramnani (certified financial planner), managing director of Francis Financial, New York, stated that if there is a large loss in the markets and you are taking out withdrawals, it could mean you are taking more money from your portfolio.

Ramnani stated that if this happens in early retirement, the recovery could be weak. It may lead to a slow or complete failure. This can jeopardize your retirement plans.

Here’s how a sequence of returns risk can impact your savings: Say a person had retired at the turn of the century with $1 million invested in the S&P and withdrew $40,000 each year, with withdrawals after the first year adjusted 2% for inflation.

Ben Carlson of Ritholtz Wealth management, director for institutional asset and financial management, said that the balance remaining in 2020 would have been approximately $470,000. crunched the numbers for a blog post.

In the above scenario, the portfolio would have been subject to a bear market at the outset of the person’s retirement, when the S&P lost 37% over three years during 2000-2002, but enjoyed a long-running bull market that began in 2009.

The order in which those returns are received is more important than the returns themselves.

Wade Pfau

American College of Financial Services Professor of Retirement Income

However, if the order of yearly returns were flipped — the gains posted by the S&P at the end of the 20 years happened first and that early bear market happened last — that same person would have more than $2.3 million after withdrawing the $40,000 or inflation-adjusted amount each year.

Pfau explained that “it’s not just the particular returns over time it’s the order of those returns”

What can you do to reduce the risk

There are ways to reduce the risks.

Pfau stated that the first step is to plan to be more prudent with your spending. The bottom line is that the more you save, the easier it will be to spend.

You can also adjust your spending if your portfolio performance is poor. 

Ramnani stated, “You need to look at all your expenses. See if you can cut any.” So maybe you cancel a trip or put off large-scale renovations that would need a lot of distribution.

Pfau stated that it is possible to actively lower the level of risk in your portfolio. You could, for example, have a lower stock allocation in retirement, but then increase it later on, or you could use bonds to cover short-term expenses, and stocks for longer-term needs.

Pfau stated, “You are strategically reducing volatility.”

You have another option: assets other than your investment portfolio to support your spending requirements when stocks perform poorly.

Pfau stated that you would “use it as a temporary source while your portfolio recovers.” 

According to him, the buffer can be either cash or a reverse mortgage loan line of credit.

In addition, the overall performance of the stock market over the past decade may make it possible to achieve your objectives without having to take on all the risks associated with stocks.

Pfau suggested that “you could take some volatility off of the table.”