Many people spend decades saving and saving in hopes of enjoying a relaxing and rewarding retirement life. But one thing he can’t plan for 25 or 30 years from retirement is the following. What will the economy look like when you reach 65, 67, 70, or the target retirement age you set for yourself?
With any luck, the economy will pick up. But what happens when the magical moment of retirement arrives, markets crash, inflation spirals out of control, and stagflation subsides?
In this scenario, retirees face at least two risks that could ruin their long-awaited golden age.
- The risk of a series of returns that affect long-term holdings.
- Interest rate risk of bond funds.
The good news is that there are several strategies that can help retirees avoid these risks and avoid potential loss exposure at each unexpected turn in their retirement journey.
Retirement Risk No. 1: Order of Return
You’ve probably come across a series of references to return risk. If not, let me give you a quick primer on how it works and how your retirement savings can quickly erode if you don’t take steps to counteract it.
Let’s say you decide to retire at age 67. You have a lot of savings to get you through the next few decades. You (or your accumulation-oriented financial advisor) believe so. However, the retirement period is a difficult time for the economy as a whole. If you’re convinced it won’t affect you (after all, you’re retired and not looking for a job), then you’re wrong.
Here’s why: When you retire, it’s very likely that you’ll need to start drawing out of your savings immediately to cover your living expenses. At the same time, increased market volatility reduces the value of your portfolio. You’re in for a double hit: The market is going through a volatile cycle and for the first time ever, earnings withdrawals are highlighting those losses.
You’ll probably be shocked to see your portfolio balance dwindle and dwindle. The market will eventually turn around, but you may be losing too much foothold to catch up. In the past, these market crashes have been great buying opportunities. Now it has the opposite effect.
Compare this to someone retiring in a great economy. In the first few years of retirement, you will see gains rather than losses in your portfolio. Yes they are withdrawing money too but with any luck their profits should outweigh those withdrawals. You will not be harmed.
Can you see the contrast? A scenario of good market results early in retirement followed by poor market results for several years is a viable scenario. This may not be the case if bad market results are followed early on by good market results.
What should I do?focus on what you can control
Obviously, you can’t predict years in advance what the market will look like when you retire. So how can you mitigate the risk of a chain of returns?
Remember, you’re withdrawing money from your retirement account, so you need to pay attention to which investments make sense to withdraw from first.
If the stock is declining in value, you don’t want to take advantage of it while the market is going down. Instead, look to low-volatility accounts such as bonds, CDs, and other low-risk investments that generally protect against losses. Make them your first stop for withdrawals while you wait for stocks to recover.
Retirement risk #2: interest rate risk and bonds
Bonds help hedge a range of return risks, but bonds funds, which is a more common investment, but does not do such things. These investments carry their own risks. You may be feeling this effect now as the Federal Reserve works to combat rampant inflation by raising interest rates.
Bondholders now enjoy stable coupon income with the peace of mind that principal will be returned when the bond matures.Unfortunately, Bond fund Holders are watching the value of this part of their portfolio plummet. This is because new bonds enter the fund at higher interest rates, making them more attractive than existing bonds that pay lower interest rates. If you want to sell a bond, you’ll find that it hasn’t reached the price it was at before interest rates started rising.
This can catch many people off guard. This is because advisors suggest that bond funds are “safe” investments and fail to explain that in such an environment of rising interest rates the principal could actually suffer significant losses.
What should I do?Get the right investment mix
Invest directly in bonds instead of using bond funds safetyThis approach reduces interest rate risk by keeping coupon payments constant and returning the invested principal in full. You can also invest in CDs and other loss-proof things.
Some conservative investors overload their portfolios with bonds (or really bond funds) and think they’re safe. I saw this a while back when a woman in her 60s came to me for help. Her previous advisor had set her portfolio as 20% equities and 80% fixed income funds. Her goal, she said, was to keep her money safe and minimize her risk.She was baffled that her own bonds were taking a bigger hit in the market than stocks. .
Finding a financial professional who can help you find the right investment mix and make sure you truly understand the risks you face is essential. These risks change as the primary investment objective moves from an accumulation phase to a distribution phase.
Whether these risks come from a series of returns, bond funds, or some other source, do everything you can to minimize the impact on your portfolio and have the kind of retirement you’ve planned for many years. You can enjoy it.
Ronnie Blair contributed to this article.
Financial Planner, Decker Retirement Planning
Bradley Geddes is a financial planner in San Francisco for Decker Retirement Planning. He is a Certified Financial Planner™ Professional and has over 13 years of experience in the areas of financial advisory, capital markets and corporate finance. He also co-founded a SaaS company in San Francisco, where he worked as his CFO before moving to this financial advisor role. Geddes graduated from the University of Washington, where he earned his Bachelor of Science degree with an emphasis in finance.
The appearance for Kiplinger was obtained through a PR program. This columnist was assisted by a public relations firm in preparing this article for posting on Kiplinger.com. Kiplinger was not compensated in any way.