Baby Boomers Face Lasting Retirement Hit In Extended Stock Rout
For baby boomers, now is a particularly bad time for a market selloff.
The S&P 500 is down more than 9% from a recent high on fears of a recession and trade-war risks. Everyone, of course, hates to see their portfolios decline. But the economic consequences could be severe if baby boomers, in particular, see their investments continue to shrink.
Much of the cohort, born between 1946 and 1964, is in the early years of retirement, or preparing to leave the workforce. And if they were to suffer persistent and deep losses while needing to withdraw money for living expenses it’s likely their portfolios would never fully recover—a scenario experts call sequence of return risk.
“Early losses while withdrawing funds can severely impact a portfolio’s longevity,” said Tomas Geoghegan, founder of Beacon Hill Private Wealth. “It’s one of the biggest but most underappreciated risks in retirement.”
The phenomenon is most dangerous when a portfolio is heavily invested in equities and an early retiree makes regular withdrawals during a prolonged downturn. The investments, already battered, contract as the assets are sold into a down market. And when the eventual rebound comes, the remaining pot of assets isn’t large enough to help the portfolio fully recover.
Should this happen to many baby boomers—in the event the recent selloff persists—the U.S. economy might feel it. Not only would the wealthiest generation be inclined to spending less in retirement overall, but they could be forced to sell even more of their assets to meet living expenses.
While the stock market has been turbulent in recent weeks, the good news for new retirees is that periods of extended losses—the kind needed to trigger sequence of return risk—remain uncommon. Amy Arnott, a portfolio strategist for Morningstar, points to four periods since 1926 when losses persisted for at least two years straight: 1929 to 1932, 1939 to 1941, 1973 to 1974 and 2000 to 2002.
Giving an example of how a 65-year-old retiree could have been hit in 2000, Arnott said a $1 million portfolio invested all in equities would have declined to $644,000 by 2020, assuming an initial withdrawal of $40,000 and annual increases for inflation.
Of course, this is a somewhat extreme case—most don’t retire with 100% in equities, and $1 million is far more than most Americans save. But Arnott said that if the bad years had came later in retirement, the value of the same portfolio could have been nearly $2.7 million after 20 years.
What to Do
Experts say sequence of return risk is most threatening in the years leading up to retirement and in the first five years after leaving the workforce. So, aside from maintaining a balanced 60/40-type portfolio, one way to mitigate the risk is to divide investments into buckets based on when you plan to spend the money.
Treasury bills or money market funds could be in the short-term bucket covering three or so years of expenses, while risker assets with more growth potential would be in the medium- and long-term buckets.
A second way to cope would be to buy a ladder of Treasury Inflation Protected Securities (TIPS) for the first five years of retirement, Arnott said.
And a third way is to adjust portfolio withdrawals roughly in line with performance. This would mean not taking the same amount (often adjusted for inflation) out of portfolios during a time when the markets are down, but being able to, within reason, pull more from portfolios in times of market gains. Planners call this the “guardrail” approach, and it’s a variation on the old guideline about withdrawing about 4% from a portfolio over 30 years to have a 90% chance of not outliving one’s portfolio.
This article was provided by Bloomberg News.