What Retirees Need To Do About This Recent Market Drop
Most retirees would think Ravi Jani is crazy. He likes to see stocks fall. The forty year old, who works in Dubai for Dow Chemical Company, began investing in a portfolio of ETFs in January 2022. Since then, he has added an average of about $15,000 a month. By September 23, 2022, his portfolio had dropped 18 percent.
“When I’m buying something,” he says, “I prefer to see a sale.” That doesn’t mean he waits for stocks to fall before purchasing. He adds money whenever he has it. But he does love market discounts.
No, Ravi wasn’t dropped on his head as a kid. His thinking is based on wisdom, history, and mathematics…as I explain here. Warren Buffett also says anyone who will be adding money to the markets for at least five more years should prefer to see stocks fall.
Retirees, however, are different. They aren’t buying market assets. Most of them are selling parts of their portfolios to cover living costs. Inflation is soaring. Stocks and bonds are falling. As a result, retirees might feel punched by a tag-team of pain.
But retirees with a responsible withdrawal plan (based on wisdom, history and mathematics) shouldn’t worry. How stocks and bonds perform today, next week or next year shouldn’t affect them. Nor should inflation.
This does, however, require Zen-like calm. And that’s tough to acquire. Take it from a guy who knows. As a cancer survivor, I have a full body MRI every year. And every year, I get sedated. Otherwise, I would bite or claw my way out. So if you’re frightened of the markets, I understand. But like my fear of close spaces, that doesn’t make it rational.
In my case, that MRI isn’t going to suffocate me. And if you’re a retiree who’s using a 4 percent, inflation-adjusted rule of thumb, market drops or inflation shouldn’t scare you either.
The so-called 4 percent rule was back-tested to 1926. Based on history, if you had a diversified portfolio of about 60 percent stocks and 40 percent bonds, you could have withdrawn an inflation-adjusted 4 percent per year and not run out of money for at least 30 years.
For example, you could have retired at history’s worst possible time (1929), made your annual inflation-adjusted withdrawals, and your money would have lasted 30 more years. You could have retired in 1973, faced a 50 percent market decline over the next two years, been ravaged by double-digit inflation in the late 1970s and still…your money would have lasted more than 30 years.
A “diversified portfolio” however, isn’t a hodgepodge of stocks put together without a plan. Such a portfolio could go south in a hurry and not recover at all. Instead, the 4 percent rule suits a fully diversified portfolio of ETFs.
However, this “rule” isn’t perfect. During most rolling 30-year periods, withdrawing an inflation-adjusted 4 percent would leave a lot of money on the table.
Below, I’ve provided an example of someone retiring 30 years ago, in 1992. In this example, I assumed the investor had a fully diversified portfolio of global stocks and global bonds. I assumed they retired with $100,000.
In the first year of retirement (1992) they would have withdrawn $4,000. That represents 4 percent of their $100,000 portfolio. Every year that follows, they would adjust that withdrawal upward to cover the rising cost of living (inflation). That’s why in 1993 (as shown below) they would have withdrawn $4,116. In 1994, they would have withdrawn $4,299. In 1995 they would have withdrawn $4,342.
Thirty years after they began such withdrawals, they would have taken out a cumulative $180,890 from their original $100,000 portfolio. Such a portfolio had its share of short-term losses. Stocks fell three years in a row: 2000, 2001 and 2002. And in 2008, this portfolio cratered 27.88 percent.
But by August 31, 2022, it would have been worth three times what they initially retired with, as shown below.
How A Strict 4% Rule Would Have Worked
60% Global Stocks, 40% Global Bonds
|Year||Inflation That Year*||Amount Withdrawn||Portfolio Value at Year End|
2022 (to 9-23-22)
Cumulative Total Withdrawn $180,890
*Based on US inflation
Note: someone from a country with runaway inflation might not think this applies to them. However, if someone’s country had runaway inflation (such as Argentina hitting 100% inflation in 2022) their local currency would have also collapsed, providing massive buying power for investments allocated in global assets (which represent a basket of global currencies).
Much depends, however, on something called, “Sequence of returns.” With the example above, the retiree didn’t begin their withdrawals during a down market. If you retired at the beginning of a market crash, you could have withdrawn an inflation-adjusted 4 percent per year from a US stock and bond portfolio and the money would still have lasted every rolling thirty year duration.
But if the portfolio were globally allocated, there would have been a few occasions when it didn’t last 30 years.
So…here’s what retirees need to do:
1. Stay global with your allocation.
US stocks won’t always be the winners. They could be among the worst performers over the next 30 years (this tends to be random stuff) so we should remain globally diversified.
2. During years when your portfolio declines, withdraw 10 percent less money than you did the year before. For example, if you withdrew $50,000 last year, and your portfolio dropped this year, you would tighten your belt and withdraw $45,000 this year. After your portfolio recovers, you could eventually boost the withdrawals upward, based on a strategy described here.
Unfortunately, too many retirees grow fearful. They shift their portfolio allocations. When portfolios fall and inflation rises, they freak out like me in an MRI.
So stay calm. Maintain a solid plan. Ignore stock market news and all economic forecasts. They’re designed to freak you out.
Andrew Hallam is a Digital Nomad. He’s the bestselling author Balance: How to Invest and Spend for Happiness, Health and Wealth. He also wrote Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas
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