Why Should Retirees Avoid Volatility?
Understanding the Impact of Large Portfolio Losses on Your Retirement Security
The following is adapted from our book, Momma’s Secret Recipe for Retirement Success. Get your copy here to read more!
We think 15-years is a long time. If you’re 70, then 15-years could represent your life expectancy. That’s why we did significant research on the S&P 500 Index starting in 1999 and ending in 2013, back when we finished writing the text of one of our books titled Don’t Bet the Farm. Because we work with retirees, we wanted to review what had happened over the previous 15 years in the stock market to prepare for what types of pitfalls may lie ahead in the next 15 years based on normal average life expectancies. There was volatility, and there was growth. But what we ultimately found out was nothing short of astonishing.
Will the Stock Market Always Go Up Over Time?
When you first started saving, you were told to “invest money,” “don’t watch it,” “don’t worry about it,” “always leave it in” and “ride it out.”
And if you did all of these things, you were told the stock market would always go up and you’d earn a really good rate of return. If you don’t believe the stock market will always go up over time, you’d better not have any money invested in the stock market! We believe the stock market will always go up over time. But that’s not the complete answer, as we must look at three variables to explain our complete opinion. We’ll explore each one below.
Variable #1: Volatility
The first variable is to determine how much volatility you have to go through during the time period your money’s invested in the stock market? If you look at the graph above showing the stock market between 1999 through 2013, you can easily see there was a tremendous amount of volatility. The Tech Bubble between 2000 through 2002 caused a huge loss, and the Financial Crisis in 2008 did the same. But if you stayed in the stock market, “rode it out” and you “never got out,” starting in 1999 you made money, you lost money in 2000 through 2002, you made back losses in 2003 through 2007, you lost money again in 2008, and then you potentially made your losses back from 2009 through 2013.
Variable #2: Time Period
The second variable is the time period money was invested to achieve the designated rate of return. In this case, the time period is 15 years, a very reasonable time period to use for analytical purposes for a retiree.
Variable #3: Rate of Return
The third variable is to then calculate the actual rate of return achieved by “riding it out” over the specified time period. Your broker or advisor may have stated you made a great rate of return by “riding it out” because the S&P 500 Index started at around 1,200 in 1999 and ended at close to 1,800 in 2013. In this article, we will discuss the annual average compounded increase to the S&P 500 Index during the 15-year time period from 1999 through 2013.
1999 – 2013 By the Numbers
From 1999 to 2000, the stock market, measured by the S&P 500 Index, went up by 19.53%, so people made a lot of money. They were happy. You probably thought the stock market wasn’t going to go down for a long time.
Then came the Tech Bubble when the S&P 500 Index lost -46% between 2000 and 2002. You were probably told to “ride it out,” and by doing so you may have lost a lot of money. You may have been fed the famous line of malarkey saying, “your loss is only on paper.” Here’s a secret: If it’s on paper, it means you lost money. It took until 2007 just to recover, and you hadn’t made any money. Fees you paid and income you withdrew could have elongated the recovery process.
After recovering by 2007, the S&P 500 Index then lost -53% from November 2007 through March 2009. It took until 2013 to break even again, not making any gains. Fees and income distributions would increase the problem. This means for these 13 years the stock market didn’t increase at all. …0%! …Zilch! …Nada!
SEE ALSO: What is a ‘Safe’ Income Withdrawal Rate?
Large Losses and Your Portfolio
So, do you think you’ll have to live through any more of these types of losses in your lifetime? If you say yes, you get an “A+” because you are correct. You will most likely have multiple of these types of losses during the rest of your lifetime. Why is this important? Because losses are very hard to makeup and the recovery is not guaranteed.
It is paramount to understand the impact of these types of large stock losses to your portfolio and your retirement security. Let’s look at data published by Craig Israelsen. He is a professor at Brigham Young University, and he wrote The Math of Gains and Losses. He stated with his research that if you suffer a 35% portfolio loss, you only have a 61.1% chance of getting back to even over any five-year time period. This means that if you suffer a 35% portfolio loss, it’s projected that almost 40% of the time you will not recover over the next five years. That’s a scary thought, isn’t it?
During retirement, you have to ask yourself one main question: Do you really have five years to hope you get back up to even, not to make money, but hope that you just get back up to even? The answer is “NO!” You don’t have five years during retirement to hope to get back up to even.
What Retirees Need to Understand About Volatility
As a retiree, the most important thing to understand about stock market volatility and large losses is that they could significantly reduce or completely eliminate the amount of income you can take out of your accounts and that your money may very well run out during your lifetime.
As a retiree, you must always remember the number one reason you saved money while you were working; so that you could use the assets for income to protect and improve your lifestyle when you were retired. You didn’t work hard and save your money to watch it go up and down and not use it, or worse, lose it during retirement. You saved it to provide you with income that would not run out for as long as you lived. And above all, you didn’t save it to have to worry about it, you saved it so that you’d have fewer worries during retirement.
If your assets are acting volatile, it won’t be impossible for you to take a high level of income out of your assets that are guaranteed to last for as long as you live. The higher the portfolio volatility, the less income you can potentially take out of your accounts.
How You Can Protect Your Retirement Security
If you’d like to talk with us about your retirement income security, please contact us today! At Peak Financial Freedom Group, we believe it’s important for you to have control over your financial future. We offer our experience and knowledge to design a specific plan of action to suit your needs and help you work toward financial independence.