Is This The Hardest Investing Environment Ever For Retirees?
Unfortunately, the investment market you retire into matters a great deal.
Today’s retirees are probably feeling as flush as ever. Virtually every investment has worked over the last decade: The S&P 500 has averaged over 14% annually, Barclays Agg Bond index has averaged over 3%, and Real Estate (REITS) have averaged over 9%. That’s about as good as it gets for investing landscapes.
While past performance is great, when you retire, future returns matter even more. In finance textbooks, they call this the “sequence of returns” risk.
To Illustrate; Here’s an example of 2 retirees in different markets:
Jack retires on 1/1/2000 (after a fantastic 90’s bull market), with $1,000,000
Diane retires on 1/1/2010 (after 2 brutal crashes during the 2000s), with only $500k
Both invest in the S&P 500 and withdraw $50,000 per year to spend in retirement.
After their first 10 years:
Unfortunately for Jack, the 2000s were a pretty difficult investing environment. He retired right before the dot com bust and then the Great Recession. By the end of 2009, he had less than $373,000 left.
When Diane retired, the Great Recession was still wrapping up and the economic waters were choppy. However, the markets went on to have a killer decade- by the end of 2019 she had over $884,000 left (even though she started with half of what Jack did!)
Clearly, early market returns in retirement can dramatically affect how your plan will play out.
The Stock Market Today
What’s troubling about today’s environment is the high asset prices for new retirees. The stock market’s starting valuation is considerably higher than historical averages:
This matters because higher-than-average prices generally lead to lower-than-average returns.
JP Morgan’s outlook observes: “This cycle is starting at an unusual point, with equity valuations elevated and presenting a headwind for returns in many stock markets”.
This makes sense because the historical relationship between starting prices and returns generally looks like a see-saw:
What About Bonds?
Because stock prices tend to be volatile, most people diversify their investments by adding bonds to their portfolio to collect low-risk interest payments. The difference in today’s environment vs past decades is that bond yields aren’t what they used to be:
Source: Macrotrends.net
What Should We Expect Going Forwards?
This scenario of high stock prices and low yields has led some prominent financial institutions to lower their 10-year capital market assumptions. Nobody has a crystal ball, but when three institutions controlling Tens of Trillions in assets agree on something, it’s probably worth listening to. Capital Market Assumptions the next 10 years:
Knowing This, How Should Retirees Adjust Their Plans?
Nobody gets to pick the market they retire into, but you can set expectations and limit mistakes to make the best of the situation:
1. Diversify Your Income Sources:
Treasury bonds pay meager interest these days, but if you’re willing to pick up some risk, assets such as high yield bonds, preferred stock, real estate or covered call strategies can enhance portfolio income levels.
2. Maximize Social Security:
Social Security is one of the only guaranteed sources of income for retirees, so making the most of it can be critical to having enough lifetime income. Avoiding the temptation to claim it at age 62 allows your monthly benefit amount to grow 8% annually, all the way up to age 70.
3. Reduce Investment expenses:
If you expect stocks to return 5% annually, paying a mutual fund 1% to invest for you probably isn’t worth the net 20% drag on returns. Besides, most actively managed funds underperform their lower-cost index fund competitors.
4. Limit Excess withdrawals:
Pulling money out today hampers future income potential. Not only will you probably pay tax on today’s distribution, that capital won’t have a chance to grow over time to larger amounts down the road.
5. Be Smart About Taxes:
Pulling money out of an IRA or 401(k) is taxable in the year you take the distribution. Additionally, our tax code has different tax rates which escalate with the amount of income you take. For example, someone who earns $81,000 in income owes 12% in federal income tax. But someone who earns $160,000 owes 22% (on those marginal dollars above $81,000) in their tax bracket. Spreading your income over different tax years can lessen the tax drag.
6. Set Realistic Expectations:
Planning for the worst and hoping for the best sounds like a cliché, but it’s likely our best shot at making retirement savings last. Good markets will take care of themselves (look at Diane’s returns from above!) but flat or downward markets are killer for those who rely on high returns to meet their goals.
If you’ve got questions on how your retirement plan is shaping up, give us a call at (530) 487-1777, or book an appointment online HERE.
Sources/Disclosures:
Jack 2000 Hypothetical
Diane 2010 Hypothetical
10 Year Treasury Rate Reference: Macrotrends.net
Active Vs Passive Funds 2020 SPIVA Scorecard
Capital Market Outlooks:
https://www.blackrock.com/institutions/en-axj/insights/capital-market-assumptions_AXJ