Will a stock market decline kill my retirement?
- Those with a sound plan based on realistic goals and expectations who stay diversified, patient, and disciplined have little reason to worry that the stock market decline seen in 2022, or even declines much worse, will radically derail their retirement.
- While the exact timing and duration of stock market declines are unpredictable, declines happen with such frequency they should be expected, not feared.
- The direct effect of stock market declines on one’s income has historically been very weak.
Will a stock market decline kill my retirement? That’s a question on the minds of many these days, especially retirees and those wishing to retire in the not-too-distant future. We thought it might be a good time to take a moment to look at this issue.
You can be forgiven for thinking the answer to that question is “Yes.” Recently, the S&P 500 index was 20% below its prior high, making the decline to start 2022 a “bear market”. The media is full of stories about how such a drop is devastating to anyone retired or wanting to be retired. This happens anytime the market declines substantially, which is to say it happens a lot. That’s the media.
Media influence aside, it is perfectly reasonable to think that since lower asset values aren’t good, declines in values must be problematic. While the exact timing and duration of market declines are unpredictable, declines happen with such frequency they should be expected, not feared. Even if the circumstance around each decline is unique, declines have been a normal part of market behavior. This is why the expectation of periodic stock market declines is built into the retirement models we construct for clients. If your plan assumes markets will not be volatile or that you can reliably predict the variability over time, you have a lousy, even dangerous plan.
If your plan assumes markets will not be volatile or that you can reliably predict the variability over time, you have a lousy, even dangerous plan.
On the other hand, if you have a sound plan built upon reasonable expectations and goals, the answer to the question, “Will a stock market decline kill my retirement?” is almost certainly “No.”
In 1994, William Bengen had a study published in the Journal of Financial Planning. He created a hypothetical retiree and split the retiree’s portfolio into one half in stocks as represented by the S&P 500 and one half in bonds as represented by 5-year U.S. Treasury notes. The portfolio was rebalanced annually. This study is where the so-called “4% rule” of a sustainable withdrawal rate originated.
Going back to 1926, Bengen determined that every such hypothetical retiree who started spending a bit over 4% of their assets or less in year one of retirement and inflated that amount every year still had money after 30 years.
Put another way, for every million dollars accumulated, every retiree in history could have succeeded if they started their retirement spending about $40,000 per year or less. All of them.
Think about that. The person who retired right before the crash in 1929 and ensuing Great Depression didn’t run out of money. Nor did the person who retired at the start of the 50%+ stock market decline which began in 1973 and the ensuing high inflation years. We’ll discuss how that is possible in a bit.
Subsequent studies showed that diversifying beyond those two asset classes (as we advocate) increased the safe starting withdrawal amount to about $45,000 per year per million dollars of assets. Other studies indicate even higher starting amounts if some assumptions are changed.
Bengen’s study assumed that spending was steadily increased for inflation every year. However, we have observed that retirees only increase their withdrawals every few years and spending naturally tapers off as they age. This is because most retirees are more active and spend more on things such as travel and recreation early in retirement, when younger.
In addition, when stocks decline or things seem tough economically, people naturally tend to be a bit tighter with their expenditures. If a good portion of a retiree’s spending is on discretionary “wants” versus true “needs,” they have an ability to scale back for a bit. Studies show the ability to curtail withdrawals by 10% for one to two years in the event of a major market decline can yield starting spending amounts closer to $60,000 for 30-year periods.
Another assumption in Bengen’s study is a 50/50 allocation between stocks and government bonds. Many retirees have had larger allocations to stocks in their working careers and have the tolerance to maintain more than 50% of their assets in stocks, especially early in their retirement. A somewhat higher allocation to stocks can support a slightly higher withdrawal rate, within limits.
So how is it that neither of Bengen’s retirees ran out of money in 30 years during the two above-mentioned downturns? The two biggest factors were bonds and rebalancing.
Bonds lose value from time to time when interest rates rise but those losses are temporary and are far less severe than the drops in value stocks can exhibit. By holding a diversified array of bonds when stocks drop significantly, the needed withdrawals can be funded by bonds coming due or sold with minimal losses.
Bengen’s study assumed 50% in bonds. If starting at $40,000 per year per million, that’s roughly 12.5 years of withdrawals which can be funded without having to sell stocks when they are down. Stocks have never gone down and stayed down for that long. Even during the 1930’s, stocks rose more than 28% in four of those calendar years (1933, 1935, 1936 and 1938).
This is where the discipline of rebalancing comes in. Rebalancing means buying more stocks when stock prices are down substantially. This buying accelerates the recovery process.
By contrast, after stocks rise, rebalancing allows for the funding of withdrawals by selling a little stock at a profit. Rather than fighting the volatility, rebalancing takes advantage of whatever volatility comes. No market prediction is required.
Rather than fighting the volatility, rebalancing takes advantage of whatever volatility comes. No market prediction is required.
That’s all well and good for retirees but what about younger people? Doesn’t a bear market set them back? Probably not. In fact, bad markets can accelerate the path to funding retirement. Younger people who have a healthy allocation of diversified stock holdings and continue saving for retirement will buy more shares when prices are down – a strategy which will pay off when stocks recover.
Those on the cusp of retiring tend to find dealing with a bear market particularly tricky, which is understandable because it can cause them to second guess their timeline. But the decision to delay retiring is largely a function of spending plans. For instance, if they were planning on withdrawing $40,000 for every million accumulated to spend on largely discretionary “wants,” the declines of 2022 are likely immaterial.
There is no magic to that $40,000 figure. It is simply the amount that has always worked. If one were to spend more in the first year of a thirty-year retirement, financial security is not endangered. The carriage doesn’t instantly become a pumpkin. For a variety of reasons, some of which we already mentioned, starting retirement with a higher spending level can be quite reasonable.
Don’t forget that these figures are all based on 30-year time frames. Thirty years is more than ten years longer than the life expectancy of a healthy 65-year-old. If you are older or otherwise have a shorter timeframe, spending levels can be higher.
All of the above is the backdrop for why we believe that those with a sound plan based on realistic goals and expectations who stay diversified, patient, and disciplined have little reason to worry that the declines seen in 2022, or even declines much worse, will radically derail their retirement.
What is more likely to cause problems is excessive spending or abandoning a sound plan at a bad time. There is good news on this: one’s spending level and the choice to stick to a sound plan are items one can control. Other controllable items are being adequately insured, employing smart tax management techniques, and controlling news intake.
We are already seeing headlines like, “A $5 Trillion ‘Wealth Shock’ Is Cracking Americans’ Nest Eggs.” Remember, the financial media is not there to help you make prudent decisions about your money. They exist to sell ads. They know nothing about you, your family, your dreams, your resources, your constraints, your temperament, your tax profile, or your plans.
Focus on what you can control. Ignore the noise. Invest, don’t speculate.
Moisand Fitzgerald Tamayo, LLC is an Orlando, Tampa and Melbourne, Florida based fee-only financial planner serving central Florida and clients across the country. Moisand Fitzgerald Tamayo, LLC specializes in providing objective financial planning, retirement planning, and investment management to help clients build, manage, grow, and protect their assets through all phases of one’s life and the many transitions in between. If you have any questions or would like to discuss anything further, please give us a call or send us a note. If you are not a client and wish to receive emails notifying you of new posts – no more than once per month – fill out the subscription information in the sidebar to the right. For more frequent updates, follow us on Facebook, LinkedIn, or Twitter.
Important Additional Information & Disclosures
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Moisand Fitzgerald Tamayo, LLC-“MFT”), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.
Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from MFT.
Please remember that if you are a MFT client, it remains your responsibility to advise MFT, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. MFT is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. Tax advice is given only to clients and only when agreed to by MFT. A copy of the MFT’s current written disclosure Brochure discussing our advisory services and fees is available for review upon request.
Please Note: MFT does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to MFT’s web site or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.
Please Note: Limitations: While MFT does NOT pay for recognition, awards, or publicity, neither rankings and/or recognition by unaffiliated rating services, publications, or other organizations, nor the achievement of any designation or certification, should be construed by a client or prospective client as a guarantee that he/she will experience a certain level of results if MFT is engaged, or continues to be engaged, to provide investment advisory services. Rankings published by magazines, and others, generally base their selections exclusively on information prepared and/or submitted by the recognized adviser. Rankings are generally limited to participating advisers. No ranking or recognition should be construed as a current or past endorsement of MFT by any of its clients. ANY QUESTIONS: MFT’s Chief Compliance Officer remains available to address any questions regarding rankings and/or recognitions, including providing the criteria used for any reflected ranking.
Historical performance results for investment indices, benchmarks, and/or categories have been provided for general informational/comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your MFT account holdings correspond directly to any comparative indices or categories. Please Also Note: (1) performance results do not reflect the impact of taxes; (2) comparative benchmarks/indices may be more or less volatile than your MFT accounts; and, (3) a description of each comparative benchmark/index is available upon request.