This month’s AARP bulletin has an article titled “Make your Retirement savings last”.
This article points out that retirement investing is for the longer term and one should not sweat short term market movements. It also points out that there is one short term danger, however, that we should all be aware of.
Let us assume when you retire, the stock market is doing very well. You take a lump sum pension payment or consolidate accounts into an IRA and fully invest your nest egg. If the market has a serious downturn lasting several years just after this transfer, it hurts the investment portfolio significantly more than if the downturn occurs 5 yrs or more down the road. Any market downturn early in retirement years is the most damaging event to be concerned about.
You may hesitate to invest if the market is making new highs every week. The legendary economist John Maynard Keynes said “the markets can remain irrational longer than you can remain solvent”. So the tendency is to get fully invested and get in on the action. I know several colleagues, who invested fully as soon as they retired only to see a serious downturn occur a few months later. If they had waited or invested over a period of time, they would have done better. Diversification alone may not have been enough.
Since market downturns cannot be predicted, how will you invest if you are retiring in the near future?
If you are a retiree, what has been your experience managing significant downturns?
Sundar Mohan Rao
During the downturn in 2008-9, and in 2020, nearly all my dividend stocks continued to pay. Yes, some banks stopped paying in 2008-9, but I acted quickly and sold off all bank and financial stocks. I used the money to buy good dividend stocks at rock-bottom prices. So my income from investments was higher than ever.
I was still working in 2008-9, but I retired in 2014.
Excellent article this week by Darius on his experience navigating market downturns
https://humbledollar.com/2024/07/protecting-my-sanity/
I’m 61 and single with no children. My 403b retirement account is 80% invested in a total stock market fund, 10% in international equities, and 10% in a TIPS fund.
That seems risky for someone planning to retire in 2-4 years, but I’m planning based on other assets.
I have 18 months living expenses in T-Bills and T-Notes, with staggered maturity dates. At 65, I’ll have a pension that will cover bare minimum living expenses, but with no COLA. I plan to claim Social Security between 67 & 70, which will double my income. Those assets let me take more risk with retirement account.
That makes sense as you will have that guaranteed income stream.
This points out something I harp on – an income stream.
I don’t think a defined benefit pension should be taken as a lump sum and a portion of after-tax investments should purchase an immediate annuity to cover basic living expenses.
For once I agree with you. I was given the choice, while I was still working, of switching my defined benefit pension to a lump sum. I looked at the size of the annuity I could buy with the lump sum and concluded that it was a bad deal. Given I have a pension with no COLA I have not annuitized any of my portfolio, but I have a moderate asset allocation and I recently set up a five year CD ladder now I expect to need income above my pension and Social Security.
Dick, I’m in agreement with the taking the BD as an annuity. There are rare cases where it might make sense to take a lump, but it needs to be carefully considered.
You mention using after-tax investments for annuitizing. Many people I know have the vast majority of their retirement savings in pre-tax retirement accounts. And most people, as you have written, don’t have a DB pension. I think that represents a large majority of folks. How would you counsel someone who has pre-tax savings, and SS as their retirement income plan?
My suggestion for after tax annuity was only to minimize the taxability of the annuity payment. Using pre-tax funds works but of course different taxes.
I have always said retirement savings should include both pre and post tax money. That is what I did. In fact, my total investments are about 50-50.
It’s probably helpful if you define who your hypothetical person is before having a definitive position.
While DB schemes are generally worth holding on to sometimes commutation rates can be favourable and help the individual diversify a little e.g. give them some upside exposure.
Immediate annuity again sounds a bit limiting especially if we’re talking bridge years before SS or a DB pension lands. It should be possible to ride out most downturns with enough capital and the right attitude. Certainly immediate annuitising would have been poor advice in a lot of the past 15 years when interest rates were very low. I know it was a mainstay of the traditional pension industry – what better than to lock a DC fund holder into permanent profit by selling them an annuity? But dependent on individual again dependent on their attitude to risk. How many people will be overjoyed to see peers who retired on less soar past them in post retirement lifestyle because the latter decided not to play entirely safety first?
I should say if you retire and in the first month equities drop 30% and don’t come back then yes immediate annuitising starts to look very smart.
I don’t think it matters. I relate to very average people looking for a secure and less stress retirement, not sophisticated investors who may be able to cope. I hope you agree that my group is the vast majority.
The only exception to taking a lump sum may be in the case of a vested pension and the worker leaves many years before retirement.
To me the security of a steady income far out weighs any possible lost earning or interest.
I live on a pension so when I see my investments fluctuate everyday it’s a very different feeling than if I had to make a withdrawal next month.
Agree, the security of a steady income makes everything simple. I could create a complex withdrawal strategy, but I worry about what happens after me.
In terms of ” after” surely having a pot which can be inherited in full might make more sense than an annuity which expires or is much reduced to a survivor?
Just taking it back to Richard’s other thread where his starting point is replacing 100% of income. Assuming a DC only pension saving plus other savings how big does that collective pot have to be to achieve 100% of income when going for safety first in an annuity? Of course they’ll want survivor benefits and COLA on the annuity too. I’d posit that it’s unrealistic for the average joe or they’ve a hell of a lot of belt tightening to do to get there unless the person wants to hold on working into their 70s.
There are several good articles available online about managing the “sequence of returns” risk in retirement. Here’s one, but there are many others. The idea is to have enough liquid stable assets to weather a downturn of X years. The idea is, if the market remains depressed for up to X years, you can avoid selling in this period, and instead use your non-stock, stable reserve.
For risk-averse individuals, X can range from 5 to10 years, though 2 to 3 years appeara to be more common. If the market stays down longer than X, then another option might be to start social security sooner than planned, although this could have negative long-term consequences for overall retirement spending.
Another common approach is turning to dividend-paying stocks, with an underlying assumption that companies generally avoid cutting dividends. However, in a down market, reinvesting dividends may be more beneficial than spending it. Strictly speaking, there isn’t much difference between receiving dividends and spending them versus selling a small portion of the shares held.
I’m a new retiree, but prior to retirement, I worked part-time for 6 years with a mindset that I’d quit if I didn’t enjoy the work. Consequently, I’ve always had a stable cushion for the last few years, although I haven’t needed to touch my buffer yet. I’m risk-averse, and for me, X is 10 years. I plan to reduce it with passage of time. Allocating a large portion to non-growth assets has an adverse effect on my long-term, but a beautiful and positive effect on the quality of my sleep :).
You are right. Another option: If we make sure passive income stream can cover expenses without dipping into investments or depending on complex withdrawal strategies, then market downturns will not matter.
As someone who is significantly in DC pension with only relatively small guaranteed pensions ( enough to cover baseline living expenses but probably not significant lifestyle/ luxuries) coming some time down the line, I’m acutely aware of SOR risk. My plan is 3-4 years needs in cash/ deposits which either gives me ability to ride out a downturn or some dry powder to buy back in.
I recognise that for a hopefully long retirement I need to stay largely invested to weather inflation and think that chasing dividend stocks for passive income is far from guaranteed in a sustained downturn.
If I make it through the first 5 years I guess I’ll be more relaxed. I could buy some annuity cover of course but I think it is relatively poor value at a relatively young age.