Mitigating or managing stock market risk prior to and after your retirement is an important step to ensure the sustainability of your supplemental retirement income. Let’s face it, running out of money is not an option. In this blog post I’m going to discuss the circumstantial risks people in retirement face and what the solutions can be. Yes, there is good news, but first we need to examine the scary stuff.
Sequence of Returns Risk
Most people understand the stock market has its ups and downs and most financial advisors will simply say, “just ride it out.” Here’s why that’s not the best advice. With sequence of returns we have a hypothetical return of 27%, 9%, 7% and -15% and that sequence continually repeats itself. With compounding that sequence will average 6%. If you start taking a 5% withdrawal(increased 3.5% each year for inflation) at the top of the sequence when the returns are positive, that 5% withdrawal rate will deplete the principal after 36 years. If you started taking that 5% withdrawal at the bottom of the sequence when the return was negative the principal would be depleted in 23 years. I really don’t want luck to play a factor in my clients’ retirement.
Stock Market Losses and Time
It’s important to understand the mathematics of what it takes to recoup stock market losses. Here’s an example. If you have $100,000 and you lose 10%, you now have $90,000, but you need to earn 11.1% just to get back to $100,000. If that loss was 30% you would have to earn 42.9% to get back to $100,000. It is important to make sure we have time to recoup from those losses. In the early 2000s and in 2008 we saw the stock market lose 50% of its value, which would require 100% return and a tremendous amount of time to get back to where you were.
Now that we’ve exposed the boogeyman, let’s look at the ways we can minimize those risks.
Tactical Money Management
Most portfolio managers will take a buy and hold approach with investments. This is also called Modern Portfolio Theory which states a diverse portfolio of non-correlated assets will maximize return over time with an acceptable level of risk. The key word in that statement is TIME. As we covered, time isn’t necessarily on the side of people approaching retirement. Yes, this strategy works great for a younger investor who has time to make up short term losses, but a retiree needs a better approach. We call that approach Tactical Money management.
Tactical means action. Action is investing based on what the economy dictates. If the stock market is heading toward a correction, we simply get out of the stock market and shift to traditionally safe harbors such as bonds, real estate, or gold. As the economy heads back in the right direction, we can shift back to stocks. With tactical money management, someone is watching every day and making effective moves to minimize short term losses and maximize portfolio growth. With tactical money management we can limit losses to be no greater than 10% during a significant stock market correction.
An annuity is a contract between you and an insurance company. We utilize fixed index annuities because they offer guarantees against stock market losses while participating in stock market index returns. With the dramatic rise in interest rates the last year or so, we have seen annuity rates at their highest level in years. As good as annuities sound, there is one negative aspect that we need to pay attention to and that is liquidity. Most annuities will only allow withdrawals of 10% each year. This is why the plans we construct only have a portion of the total porfolio added to an annuity with the remainder helf in tactfully managed accounts which are 100% liquid.
Contact our office at (480) 428-8005 if you would like to learn more.
Written by Marc Montini, IAR and licensed fiduciary.