Mr. Cowles' piece is actually about dealing with his anxiety. Investment results are just one cause of his angst (see his second paragraph below for a more complete inventory) but those results illustrate quite well the concepts of risk tolerance towards short-term portfolio volatility that I discussed in Homo Economicus compared to risk tolerance towards long-term volatility. The first two paragraphs from that Times piece are relevant to retirement:
When the stock market crashed in 2008, my wife and I were 70. And we saw half of our retirement funds disappear. Before the crash, we felt secure in the belief that we had enough money to last as long as we lived; after the crash, we feared that we would not, and I worried about it a great deal. I had a hard time going to sleep and an even harder time going back to sleep after getting up to go to the bathroom in the middle of the night. I came to hate going into that bathroom because I knew my demons resided there and would invade my consciousness immediately.
By the time the stock market began to recover and our savings were again at a comfortable level, I had become conditioned to associate my nightly bathroom trips with “worry time.” I would worry about everything: home repairs, trip planning, medical issues and all the vicissitudes of old age, fears of infirmity, dying and seeing my friends and loved ones die.It was probably not Cowles' intent that my first thought after reading his article would be that his stock allocation had been too high, but it was. The stock market fell a little more than 50% from late 2007 to early 2009, so the Cowles must have been fully invested in equities. They had laid a lot of chips on the table.
I'm not a doctor, but if you can't sleep at night because you're worried about losing your retirement standard of living in a market crash, you have too much of those savings invested in stocks. If you can't sleep and need anti-anxiety medications because you're worried about your portfolio, you have way too much invested in stocks.
[Tweet this]"When the stock market crashed in 2008, my wife and I were 70. And we saw half of our retirement funds disappear."
Cowles notes that “the stock market began to recover and our savings were again at a comfortable level,” though he doesn't say they fully recovered. His portfolio will probably eventually recover, assuming he didn't bail out at the bottom of the crash, but that's the big risk.
If Cowles decided near the bottom of the crash that in addition to finding anti-anxiety meds, religion, and meditation he needed to eliminate a source of the anxiety, he might have chosen to reduce his equity allocation (sell stocks). A lot of research shows that investors tend to buy at the top and sell at the bottom. With a lower allocation to stocks after the fall, the climb back uphill becomes even harder. Your equity allocation will already be lower because your stocks will have fallen faster than your bonds. Selling more stocks makes it worse.
As I mentioned in Homo Economicus, it's important to understand your risk tolerance before you retire. If you guess that your tolerance to short-term volatility is higher than it turns out to be, you are faced with two unattractive options near the end of your first bear market after retiring. You can sell equities to stop the bleeding, increase the sleeping, change your asset allocation to where it should have been all along, and severely hamper your prospects for fully recovering.
Or, you can fight through the pain and convince yourself, as your stockbroker tried to do, that the market always recovers. Keep in mind, of course, that your savings portfolio isn't the market.
The Cowles say they saw half their retirement savings disappear in 2008 at age 70. That's a lot of stress when you have no career to return to.
Insuring that you have a solid floor of income from assets not tied to the stock market may ease the pain of a bear market.
Perhaps you're one of the 14% of respondents to my informal survey (bottom of that page) who eats risk for breakfast, sleeps well and never takes anything stronger than vitamin C. In that case, your asset allocation should be based on factors other than short-term volatility. But if you're one of the 84% of respondents who need some bonds to help you sleep, or the 2% who want nothing to do with stocks in retirement, your tolerance to short-term volatility should be a factor in your asset allocation. That stock allocation may be smaller, for example, than one that would optimize a safe withdrawal rate over the long run.
I apologize that this post and the previous are somewhat redundant, but it's an important point and sometimes a real-life scenario is more convincing.