Sure, if you’ve got time you can ride a stock market decline back up. But what if you’re retired or near retirement?
Last week, the Dow Jones industrial average declined nearly 1,400 points in just two days.
Are we headed for spookier drops?
I asked Carolyn McClanahan, a certified financial planner based in Florida, what she would tell folks who are concerned about the stock market declines.
Q: What advice would you give people who are about to retire or are already retired and actively managing their savings, given the recent turbulence in the markets?
McClanahan: “People who need their money or are close to needing their money need to address their asset allocation — most are too aggressively invested! Ask yourself, if you are invested 100 percent in stocks, would you be okay losing 40 percent? That was the correction in 2009. If you aren’t okay with that, you need to reduce your stock exposure and put money in bonds. Although bonds are boring, they are the safety net in turbulent times.”
Read more: An early retirement is doable. Here’s how.
Q: Long-term people have time to wait for the returns to even out. But what if you're right in the middle of needing your money? What should you do?
McClanahan: Michael Kitces and Wade Pfau did a study showing that retirement success is much more likely if you are conservative early in retirement, and as you age increase your equity exposure. This is termed a ‘rising equity glide-path.’
Here is a link to their article: Reducing Retirement Risk with a Rising Equity Glide Path
“For those households looking to maximize their level of sustainable retirement income, and/or to reduce the potential magnitude of any shortfalls in adverse scenarios, portfolios that start off in the vicinity of 20 percent to 40 percent in equities and rise to the level of 60 percent to 80 percent in equities generally perform better than static rebalanced portfolios or declining equity glide paths,” Kitces and Pfau write in the article for the Journal of Financial Planning,
Q: So, you’re retired or near retirement and you’re heavily in equities. Do you sell now and reduce your risk while the market is down thereby locking in your losses?
McClanahan: “Yes, we’ve had a correction and it is a wake-up call. What if the market goes down another 30 percent? How are you going to feel? The key is for people to understand how much risk they can take and how much they can afford to lose. The market doesn’t always come back — look at the 20 years after the great depression. If you have to be aggressively invested to fund your lifestyle, it probably means you need to keep working. We can’t count on the stock market to take care of us for 30 or 40 years."
Q: Bonds are safer but what about inflation? If we are living longer, won't you need more growth? How do you decide how much in stocks and bonds to get both growth and safety?
McClanahan: “Inflation is why you need to own some stocks, but if you own too much, any big market down turn will lose you way more than inflation will eat into your portfolio.”
Q: If you've got a good mix of stocks to bonds depending on your risk tolerance how do you still not panic? It's easy for people with money to say don't worry but they have money they can afford to lose while they wait for an even out of stock returns.
McClanahan: “People who are prone to panic despite having an appropriate allocation would probably be best served by hiring an adviser who will provide them calm and objectivity during turbulent times.”
Have you decided to make changes to your retirement portfolio based on recent events in the stock market? Send your comments to email@example.com. Please include your name, city and state. Put “Stock Market” in the subject line.
Retirement rants and raves
I’m interested in your experiences or concerns about retirement or aging. What do you like about retirement? What came as a surprise?
If you haven’t retired yet, what concerns you financially?
You can rant or rave. This space is yours. It’s a chance for you to express what’s on your mind. Send your comments to firstname.lastname@example.org. Please include your name, city and state. In the subject line put “Retirement Rants and Raves.”
I want to continue the conversation from last week’s newsletter on whether you should pay off your mortgage before retirement.
I asked readers: Did you pay off your home before retiring? How’s that working for you? If you still have a mortgage how’s that working for you?
The overwhelming majority of people who responded had paid off their mortgage before retiring. But there were some who decided to keep their low-interest rate mortgage. They would rather invest any extra money they might have used to pay down their principal and invest it instead.
Jim Bowerman of Pawleys Island, S.C., wrote, “While I understand the appeal of not having monthly payments, I do not see the importance of paying off a mortgage. If the mortgage interest is 3 5/8 percent, and you have the cash, why not invest in a broad based equity fund? Historical return on equity mutual funds over the 30-year life of the mortgage is around 8 percent, higher than the cost of the interest. This works if you have enough cash in bonds or other short-term assets to cover monthly payments on the mortgage during a stock market downturn. That is a BIG IF, so make sure it is true!”
“We sold our primary home and moved into our retirement home,” wrote Ken Thetford of Bethany Beach, Del. “The proceeds from the sale invested at a conservative 5-6% will pay the monthly mortgage, interest and taxes of our current home with some extra. However, I am making the monthly payments out of my retirement income, letting the entire sum of the proceeds plus the investment earnings build. Yes, I could pay off the mortgage and invest the monthly savings but even compounding needs time to work its magic. If things go badly I can always withdraw the funds and payoff the mortgage. If having a mortgage is going to keep you awake at night, then I say pay it off. I like having options and this approach provides much greater flexibility, provides a substantial increase in my investable assets, and generally allows greater flexibility when planning for increased medical expenses and possible long term care options.”
“Liquid cash is important with today’s uncertainties,” wrote Jean Helm of Moorpark, Calif. “We will buy a downsized retirement home sometime in the next year outside of our current state. Property is much less expensive where we are moving. We will put a sizable down payment toward the house — cash that we have saved, not any 401(k) money — and then will put the rest of the cash in an account from which our small mortgage will be paid. We want the liquid cash to cover any emergencies without touching large chunks of any 401(k) or IRA.”
Bob Blair of Concord, N.H., wrote, “My mortgage principal is $240,000. My interest rate is 2.85 percent. My investment income for the last two years was over 16 percent per year. I have no reason to pay off the mortgage. Reason should rule over emotion.”
Be sure when making comparisons with paying off your mortgage to investing you don’t forget to include the interest you’d save from an early payoff. And you could also invest the mortgage payments you would have made. Also take into account taxes and fees on your investments. Additionally, paying off the mortgage and saving the interest expense is a sure thing. Returns are not.
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