2 risks people face if they retire in times of economic crisis
Many people save and save for decades in the hope of enjoying a relaxing and rewarding retirement. But one thing that’s impossible to plan for when you’re 25 or 30 years away from retirement is this: what the economy will look like when you reach 65, 67, 70, or whatever target retirement age you fix?
If you’re lucky in an economic recovery, good for you. But what if you finally reach that magic moment of retirement and the market crashes, inflation is out of control and stagflation has set in?
In this scenario, retirees face at least two risks that could tarnish their long-awaited golden years:
- Sequence of returns risk, which affects long-term holdings.
- Interest rate risk in your fixed income bond funds.
The good news is that there are several strategies to help retirees maneuver through these risks and dodge the exposure to losses that can occur at every unexpected turn in the retirement journey.
Retirement Risk #1: Sequence of Returns
Perhaps you have already come across references to the sequence of yield risks. If not, let me briefly explain how it works and how it can quickly erode your retirement savings if you don’t take steps to address it.
Let’s say you decide to retire at age 67. You have significant savings to see you through the next few decades – or so you (or your accumulation-focused financial advisor) believe. But times are tough with the overall economy as you retire. If you’re convinced it won’t affect you (you’re retired, after all, and not looking for a job), you’re wrong.
Here’s why. At the start of your retirement, chances are you will need to start withdrawing money from your savings immediately to help pay for your lifestyle. At the same time, an increase in market volatility leads to a decrease in the value of your portfolio. You suffer a double whammy: the market goes through a volatile cycle and, for the first time, your income withdrawals compound those losses.
You may be shocked to see your wallet balance dropping and dropping again and again. Eventually the market will turn around, but you may have lost so much ground that you will never be able to catch up. In the past, these market declines were excellent buying opportunities. Now the opposite effect occurs.
Compare that with someone retiring in a big economy. In the early years of retirement, they see gains in their portfolio, not losses. Yes, they also withdraw money, but hopefully their winnings should exceed those withdrawals. If, later on, the market goes down, they won’t be as affected as you are because of those early years of portfolio growth.
Do you see the contrast? Good market performance in the early years of retirement, followed by poor market performance in later years, is a survival scenario. Bad market results at the start, followed by good market results later, may not be.
What to do? Focus on what you can control
Of course, you can’t predict years in advance what the market will be like when you retire. So what can you do to try to mitigate sequence of returns risk?
Well, remember that you’re taking money out of your retirement accounts, so you have to be careful which of your investments it makes sense to dip into first.
If your stocks are losing value, you want to avoid tapping into them when the market is down. Instead, look to less volatile accounts, those that generally protect against losses, such as bonds, CDs and other low-risk investments. Make it your first stop for withdrawals while waiting for stocks to rebound.
Retirement risk no. 2: interest rate risk and bonds
While bonds can be helpful in avoiding the return risk sequence, bonds funds, a more common investment, do no such thing. These investments carry their own risks. You may even be feeling this effect right now as the Federal Reserve works to fight runaway inflation by raising interest rates.
Bondholders currently receive a steady stream of coupon income with the peace of mind that their principal will be repaid when their bonds mature. Unfortunately, the link funds holders watch the value of this part of their portfolios plummet. This is because new bonds enter the fund with a higher interest rate, making them more attractive than existing bonds that pay the lowest rate. If you want to sell your bonds, you will probably find that they do not command the price they had before interest rates started to rise.
This may catch many people off guard, as their advisors have suggested that bond funds are “safe” investments without explaining that their principal may indeed suffer substantial losses in a rising rate environment, such as this.
What to do? Get the right mix of investments
Instead of using a bond fund, invest directly in the bond Security. This approach reduces your interest rate risk because the coupon payments remain constant and the full investment principal will be returned to you. You can also invest in CDs or anything else that protects against losses.
Some conservative investors overload their portfolios with bonds (or rather bond funds) thinking they are safe. I saw this not long ago when a woman in her 60s came to me asking for help. A previous adviser had made her portfolio 20% stocks and 80% bond funds. His stated goal was to keep his money safe and take little risk. She was baffled that her bonds were hit harder in the market than her stocks.
It is imperative to seek out a finance professional who can help you find the right combination of investments and ensure that you truly understand the risks you face. These risks change as you move from years of work, with your primary investment objective based on accumulation, to a distribution phase.
Whether those risks are caused by the sequence of returns, bond funds, or something else, you want to do everything possible to minimize the impacts on your portfolio, so you can enjoy the kind of retirement you’ve been planning for so many years.
Ronnie Blair contributed to this article.
Financial Planner, Retirement Planning Decker
Bradley Geddes is the San Francisco Financial Planner for Decker Retirement Planning. He is a CERTIFIED FINANCIAL PLANNER™ professional and has over 13 years of experience in financial advisory, capital markets and corporate finance. He also co-founded a SaaS company in San Francisco and worked as the company’s chief financial officer before taking on that role as a financial advisor. Geddes is a graduate of the University of Washington, where he earned his Bachelor of Science degree with a major in finance.
The appearances in Kiplinger were obtained through a public relations program. The columnist received help from a public relations firm to prepare this article for submission to Kiplinger.com. Kiplinger was not compensated in any way.