The following is adapted from Keep It Simple, Make It Big.
Imagine you’re climbing Mt. Everest: what is your goal?
Your first thought might be, “Get to the top.”
This is intuitive, but when you get to the top, are you done climbing? No, you still need to climb back down.
So the goal is to not only reach the peak but then also to make it down safely to tell the tale. I am told that descending the mountain is more dangerous than the climb up.
Retirement is the same way. Investing over the working years is the initial climb. The start of retirement is the top of the mountain, but you’re not done yet. You need to make it to the end of your retirement.
And just as descending the mountain is more dangerous than the upward climb, making it through retirement can be more challenging than the initial savings. If a stock market decline happens early in retirement or often and deep enough, it can wipe out an investment portfolio and seriously impair a person’s retirement.
To make it to the bottom of the mountain—to the end of your retirement—you must be prepared to face multiple stock market crashes in your retirement.
The Ups and Downs of the Market
In investments, the past is never a prediction of anything specific about the future. Past returns should never be relied upon for proof that any given investment is appropriate, good, or will perform well in the future.
That said, financial markets themselves are broad, complex systems that have years of well-studied and documented history. And just because specific downs and ups cannot be predicted with accuracy, you can take the fact that there will be ups and downs to the bank.
Once you know what is normal, it can relieve some stress. It’s like the two scariest rides at the California Disneyland when I was a kid: Space Mountain and the Matterhorn. These rides were scary because riders were in the dark and couldn’t see the track.
Understanding normal market fluctuations will show you the track. You may still lose your stomach from time to time, but it won’t be as scary, and you can create a system that will prevent you from losing your mind.
How Often Do Declines Happen?
Looking at 117 years of the widely quoted Dow Jones Industrial Average, we can see how frequent declines are, with 5 percent pullbacks occurring, on average, three times a year, 10 percent pullbacks once a year, and 20 percent drops once every four years. Yet over this period the Dow returned 7.32 percent without dividends reinvested.
For the S&P 500, a broad index that contains the 500 largest publicly traded US companies, volatility is also the norm, not the exception. In an average, twelve-month span, it will decline 14 percent. These downs are the price paid for the ups. Over the last thirty-nine years, ending in 2018, it ended positive twenty-nine years, with an average return of 8.4 percent compounded. This is without dividends reinvested.
Now few people only invest in large US equity positions. Most also have bonds and other equity classes. But this is the most-quoted market and the one that defines most returns.
So while you can expect periodic declines, over the long run, you can expect growth. As long as you can hold on to your assets through the down markets, they will usually regain their value.
Three Plus One Equals Four
Given this reality, I often counsel people to think in units of four years. On a calendar-year basis, markets end the year up three years and down one.
If you retire at 65 and live to 95, you will have thirty years in retirement.
Divide 4 into 30 and you get 7.5. This means that on average there will be between seven and eight times in retirement when the US stock portion of your account is substantially negative on a calendar-year basis. It also means you will have twenty-two years that should be positive, again, based on historic relationships.
When the down year arrives, you face a choice. You can be sad because your portfolio is down or happy because you only have five drops more to go!
More importantly, if you can understand these relationships and believe in them, you can confidently build an income reservoir (a pool of money that is liquid and not tied up in stocks), switch your withdrawals to stable low-return assets, and avoid either downgrading lifestyle or depleting a portfolio. This is the key to a financially successful retirement.
Make it to the Bottom of the Mountain
To make it to the bottom of the mountain, you must expect and plan for market downturns.
The key is to avoid selling low, as this will deplete your principal investments. By creating an income reservoir, you give yourself breathing room. I recommend having three to five years of income in your reservoir, so that even in the case of an extended downturn, you are not forced to sell off stocks at a low point.
It would be nice if the stock market only went up, but that’s simply not realistic. By expecting multiple downturns throughout your retirement, you can better plan how you’ll get through the declines so that you can make it to the bottom of the mountain safely.
For more advice on preparing for retirement, you can find Keep It Simple, Make It Big on Amazon.
Michael Lynch is a Certified Financial Planner with nearly twenty years of experience working with American families to craft plans that fund their dreams, educate their children, and finance their retirement. Michael has contributed to the Wall Street Journal and Investor’s Business Daily, and hosted Smart Money Radio for a decade. He’s served as an adjunct faculty member at Fairfield University and currently teaches financial planning to employees of corporations like Madison Square Garden and Yale New Haven Health Systems. Michael is a five-time Financial Planner of the Year for MetLife and a 2019 inductee to the Barnum Financial Group Hall of Fame. You can enjoy his latest articles and videos at www.michaelwlynch.com.
Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Michael Lynch is a registered representative of and offers securities and investment advisory services through MML Investors Services, LLC. Member SIPC. www.SIPC.org 6 Corporate Drive, Shelton CT 06484 CRN202210-272647