I mentioned in my last post that
there is a larger message than “investing is really tough after you
retire”. It’s about the amount of risk you can handle after retiring. It
will be much harder to recover from steep portfolio losses after you
simultaneously begin spending your savings and foregoing new savings
contribution — and your employer’s match, if you get one.
The
mantra of the financial services industry is “just hang in there
through bear markets and you’ll eventually earn it all back.”
But it’s a different game after you retire. Your portfolio will recover much more slowly.
Your
retirement savings account is like a rain barrel. Rains (stock market
gains) fill the barrel. While you’re working, you dump in a little more
water from the faucet (savings contributions) on a regular basis. You
never take any out. The barrel fills relatively quickly.
After
retiring, you not only stop dumping in regular additional water, you
begin drinking the water daily (spending your savings). It’s a different
equation.
The
financial services industry will tell you that stocks get safer the
longer you hold them. They don’t. To quote Zvi Bodie, stocks are risky
no matter how long you hold them. And the longer you invest, the larger
your portfolio becomes and the more money you lose when the market drops
say, 15%.
They
say that if you simply stay in the market long enough, your portfolio
will eventually recover its losses. That part is probably true, so long
as the U.S. economy continues to grow and you gloss over “long enough”.
The
2007 crash took about 5 years for the S&P 500 to correct, but that
probably isn’t the same as your own portfolio. Most investors don’t see
anywhere near market index returns or invest solely in an S&P 500
index fund, so your individual recovery time may be much longer. Also,
working investors are probably adding new savings while retired
investors are probably spending some of their savings.
Let’s look at Working Guy and Retired Guy and how each might have fared after 2007.
When the S&P 500 peaked in October 2007, Working Guy and Retired Guy both had retirement savings portfolios worth $100,000.
Working Guy saved $4,000 a year in a 401(k)
plan and never had to spend any savings before retirement. His paycheck
covered the bills. His employer contributed a matching $2,000 each
year. He held 80% of his portfolio in an S&P 500 index fund (SPY)
and 20% in Vanguard Total Bond Market fund (VBMFX).
Retired
Guy no longer contributed to retirement savings and he had decided to
spend 4.5% of his initial portfolio value each year, or $4,500. Retired
Guy knew he should take less market risk after he retired, so he held
only 20% of his portfolio in the same stock index fund as Working Guy
and the remainder in the same Vanguard Total Bond Market fund.
In
a year when the market breaks even, Working Guy’s portfolio increases
$6,000 and Retired Guy’s portfolio shrinks $4,500. That $10,500
difference every year is a lot — 10.5% of a $100,000 portfolio.
The following chart from Yahoo! Finance data
shows what happened to the S&P 500 index fund SPY. After peaking in
October 2007, the index fell 54% by March 2009. It recovered its
October 2007 peak value in August 2012, 4 years and 10 months after it
peaked.
An investor who stayed fully invested in an S&P 500 index fund would have recovered his portfolio value in that 58 months if he neither continued to save nor spend from his savings.
But Working Guy saves $6,000 a year while Retired Guy spends $4,500.
As
you can see in the next chart, Retired Guy’s 30% stock portfolio fell
17% and Working Guy’s portfolio fell 37% before heading back upward.
Working Guy’s losses would have been even greater because of his larger
stock allocation, but Working Guy and his employer shoveled $9,000 of
new cash into the teeth of a gut-wrenching, money-shredding, 17-month
decline while Retired Guy did not. Not only did Retired Guy not put more
money into his portfolio, he spent $6,750.
Working
Guy’s portfolio then moved upward and recovered in January 2010, 27
months after the market’s peak and 31 months sooner than the S&P 500
index.
In
August 2012, media pundits were saying, “If you had only stayed in the
market, you’d have recovered your losses by now.” But that wasn’t true
for either Guy, was it?
Working
Guy’s portfolio had actually recovered 31 months earlier and Retired
Guy’s 20% stock portfolio wouldn’t recover for 9 more months. In fact,
had Retired Guy held more than 30% of his portfolio in stocks, his
portfolio still hasn’t recovered after nearly 6 years.
If
the bull market continues, a “Retired Guy” 40% portfolio will probably
recover in a year or so, taking twice as long as Working Guy’s. If the bull market continues.
On
the other hand, the nature of retirement portfolios is that they will
be spent down over the retiree’s remaining life and it’s quite likely
that many retirees and near-retirees who endured the 2007-2009 crash
will never recover their October 2007 portfolio value.
If they had it to do over, they would have held less stock.
My
point in all this is that it is much harder to recover from a severe
market decline after you retire than it is before. See that blue line on
the chart? That ain’t you, anymore. That line is headed upward,
probably, until retirement. Yours is probably headed the other way.
When
you get older, everything heals more slowly. Even your portfolio. You
have to think hard about not getting hurt badly in the first place.
In
the decade before retirement, when we can make “catch-up contributions”
to retirement savings, we become really spoiled by fast recoveries from
crashes. We become confused about how much of our “investment skill” is
actually just saving more.
When
the super-saving stops and the drawing down of savings begins, our
sleds hit that patch of dry pavement at the bottom of the hill. Our
momentum dies quickly and then we have to carry the sled back up that
hill.
The sled ride downhill is a lot more fun.
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Note: I must apologize for a spreadsheet error in the initial draft of this post that over-valued bond portfolios for Retired Guy. The result was that the 63-month recovery period reported for Retired Guy's 40% portfolio should have been a 67-month recovery for a 30% portfolio. Correcting this mistake actually strengthens the arguments. Only a 30% Retired Guy portfolio has recovered its October 2007 value as of this writing, so the 40% portfolio used was replaced with the 30% portfolio.
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Note: I must apologize for a spreadsheet error in the initial draft of this post that over-valued bond portfolios for Retired Guy. The result was that the 63-month recovery period reported for Retired Guy's 40% portfolio should have been a 67-month recovery for a 30% portfolio. Correcting this mistake actually strengthens the arguments. Only a 30% Retired Guy portfolio has recovered its October 2007 value as of this writing, so the 40% portfolio used was replaced with the 30% portfolio.
Event
|
Date
|
Months after October 2007 Peak
|
S&P 500 peaks at 14,164
|
October 9, 2007
| |
S&P 500 reaches a bottom at 6,6594, down 53%
|
March 5, 2009
|
16
|
Working Guy’s portfolio recovers
|
January 14, 2010
|
27
|
S&P 500, adjusted for splits and dividends, recovers to October 2007 level
|
August 16, 2012
|
58
|
Retired Guy’s 30% Stock Portfolio recovers
|
May 21, 2013
|
67
|