How Can Market Downturns Affect Your Retirement Income?

market down effects retirement income

For skiing enthusiasts, the concept of ups-and-downs is quite exhilarating. Just the thought of cutting powder on tall, sloping moguls can make even the “hard cores” blush.

But as recent market volatility reminds us, the goodwill doesn’t apply to ups-and-downs in every situation. Sometimes it can bring just the opposite.    

Earlier this month on Morningstar, Director of Personal Finance Christine Benz observed how equity market down-spurts can disrupt a retirement portfolio.

Portfolio losses might not matter as much as when people are younger, as they have time to recover – and to grow past the point when portfolio asset values dipped. In fact, Benz writes, for those with many years to retirement (or under age 50), "not taking full advantage of the historical outperformance of riskier asset classes is a bigger risk than being too conservative."

But as retirement draws near, some flight to safety may well be a prudent course of action. Benz explains: "At that life stage, you're much more vulnerable to what retirement planners call sequence of return risk. That means that if you encounter a calamitous equity market early on in retirement and need to spend from the declining equity portfolio, that much less of your investments will be left to recover when stocks finally do."

And what if a portfolio has gone into reverse mode? "Your only choice to mitigate sequence of return risk--assuming your stock portfolio is in the dumps and you don't have enough safe investments to spend from--will be to dramatically ratchet down your spending," Benz says. "Needless to say, that's not something most young retirees are in the mood to do."     

Retirement, a Time for Change

In an advisor-facing article on FTAdviser (a publication of Financial Times), Henry Cobbe talks about preparing for accumulation and decumulation. The goal of lifecycle investing, he writes, is to “create an asset allocation over time that changes with the shifting objectives over an investor’s lifecycle.”  

Citing a landmark monograph by economists Roger Ibbotson, Moshe Melevsky, Peng Chen (CFA), and Kevin Zhu, Cobbe mentions the three basics stages of the money lifecycle:

“The investment lifecycle can be broken into three phases: an accumulation phase, a preservation phase, and a decumulation phase. During the accumulation phase, investors convert a portion of their income into capital based on a 'contribution rate'. While during the decumulation phase, investors convert a portion of their capital into income based on a 'withdrawal rate'.”

In regard to portfolio objectives, the accumulation phase generally has a growth bias, according to Cobbe.

They operate largely on a risk-and-reward calculus, with initial portfolio balance, account contribution rates, and real capital growth (i.e., portfolio growth net of inflation) being the fundamental variables.

Decumulation Means Slowdown

Not so for the decumulation phase of life however, Cobbe explains. Rather, portfolio objectives in the decumulation stage generally have an income bias. They aim more toward what Cobbe calls “portfolio durability.”

In this sense, durability means having a portfolio “that can support a level of withdrawals that can adequately fund a retirement income stream over an expected time horizon.” With retirement life stretching out for decades due to advances in medicine and technology, the challenge is ensuring enough financial resources for a comfortable retiree lifestyle.   

And what about the fundamental variables in the decumulation phase? According to Cobbe, it’s "a function of initial [portfolio] size, withdrawal rates, and capital preservation in real terms (again net of inflation)."

Now it’s a matter of ensuring your money and assets last as long as you need them… to supplement your long-term retirement income needs.

Doing so will help counteract what Cobbe calls the "key risk factors” for a decumulation portfolio: “longevity, liquidity, volatility, and low returns.”

Lessons from the Financial Crisis

As you may have seen first-hand, the market crash of 2007-2009 pulled down the income security of millions of Americans. Mauricio Soto of the Urban Institute has found that between September 2007 and December 2008 alone, Americans lost over $2.8 trillion in their retirement accounts. Or 32% of their total value!

In her column on Morningstar, Benz recounts the experience of a relative during the financial crisis. She and her family were vacationing abroad in late September 2008.

One of her relatives was feeling the heat as equities kept plunging in a downward spiral:

“The market was tumbling, and one of the family members who had joined us was in a state of panic. Though she was still several years from retirement, she was convinced that she wanted to sell all of her stock holdings. The news about the markets and the state of the global economy seemed to be going from bad to worse by the moment.”

Unlike other people, however, she wasn’t all that close to retirement yet. Benz recounts how another relative jumped in, reinforcing that since she wasn’t due to retire soon, she should stop worrying and enjoy her vacation.

That proved to be the right advice for the family member at that point.

Although the "stop-and-forget-it" advice may have been good at that time, Benz explains it wouldn’t necessarily be good for her relative today. Why? Because unlike then, her relative is now close to retirement. And it brings new risks of its own.

Experts: ‘Wait and See’ Not Always Best

Benz says why this "wait-and-see" approach may not be the best strategy for her relative, given that she’s closer to retirement age.

"I wouldn't necessarily give that same family member the same advice today, in the wake of the market's recent swoon. No, I don't have any insight into whether the current market volatility will be a short-term blip or the beginning of something really bad," Benz explains.

"But I do know something about my relative: Now she is ready to retire and will be drawing upon her portfolio for living expenses. That means that the approach that made sense for her 10 years ago -- don't sell any stocks! -- may in fact be ill-advised today. If she hasn’t taken steps to reduce her equity exposure in the interim, cutting the stake now in favor of safer investments could, in fact, be precisely the right course of action."

Being Retired is a Different Ballgame

According to Benz, a danger that can creep up for people close to retiring is heeding advice that might not apply to their financial picture.

Apart from being in the distribution or decumulation stages, near-retired people also have their own personal situations. Just monthly income and spending needs might vary greatly from person to person, says Benz.  

Such personal differences are a “key reason why I often cringe when I hear one-size-fits-all recommendations during volatile markets,” she writes. “Even as well-meaning market observers exhort everyone to ‘stay the course,’ not everyone should, actually.”

“People getting close to retirement or those who are already retired are courting serious risks by standing pat with too-aggressive portfolios.”

Don’t Forget the Human Factor Too

Not to add insult to injury. But there can be another, self-defeating risk when it comes to financial retirement planning: personal behaviors in regard to portfolio and money decisions.   

“Your past behavior in market declines isn't always a great indicator of how you're apt to behave in the next big downturn. Even if you sailed through the 2007-2009 market meltdown without undue worry or panic-selling, the next downturn could prove more visceral if retirement is closer at hand and starting to seem like a realistic possibility,” explains Benz.

"It's not fun to see your portfolio drop from $500,000 to $225,000 when you're 45. But it's way worse to see your $1 million portfolio drop to $450,000 when you're 55 and beginning to think serious thoughts about the when and how of your retirement.”

In short, the challenge is thwarting knee-jerk reactions, avoiding panic-action decisions, and maintaining a calm discipline toward your retirement finances. It’s important to remember that your future is on the line.

Start Getting Your Financial House in Order

While an accumulation-phase strategy may have helped you with portfolio growth, your needs will evolve in retirement.

For those in their fifty-somethings and above, this is a period of preservation and decumulation. Generally, portfolio assets, investments, and life savings replace sources of income from entrepreneurship or full-time employment as sources of retiree livelihood. They might be what help you cover the monthly costs, and other expenditures, of your retired lifestyle.

If your financial plan still operates on accumulation-phase principles, it may be time for a plan check-up.  

Need Assistance from a Financial Professional?

You may consider a second opinion from financial professionals who understand retirement as well as its unique risks and challenges.

Be sure to confirm that any financial professional who may help you with your retirement strategy understands the importance of planning for retirement income. They can help you evaluate your existing income strategy, explore other options if needed, and see if you can take any more steps toward achieving your financial goals.

Should you be ready for such guidance, financial professionals at stand ready to help you. Use our “Find a Financial Professional” section to connect with someone directly. If you need a personal referral, call us at 877.476.9723. 

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