Develop a thoughtful strategy for investing in retirement.
Are you an older worker or retiree who’s worried about the recent volatility in the stock market? If you’re at this stage of life, the challenge you face regarding your future financial security is that you’re going to need to rely more on your financial resources than on your future earning power.
But a little fear can be a good thing, because it causes you to pay attention. Here are two tips to help you address your reasonable fears:
- Learn from the history of stock market returns.
- Protect yourself against stock market declines that are inevitable if you live a few more decades.
The historical perspective
The chart below illustrates the annual percentage returns, including dividends, in the S&P 500 since 1926. You can see that 2019 produced a 31% gain, following an 4% loss in 2018, which represented the first annual loss in the stock market after a nine-year winning streak.
Stocks have produced positive returns many more years than losses
Reflecting returns through March 3, the S&P 500 has lost about 7% in 2020, reversing a fraction (under one-fourth) of 2019’s significant gain. So if you had invested significantly in stocks since the Great Recession, your investments would be way ahead, even with the losses incurred so far in 2020.
The above chart shows a significant “double double” advantage for the stock market:
- There are more than twice as many “up” years as “down” years—69 “up” years compared to 25 “down” years.
- The average gain during the up years was almost twice as much as the average loss in the down years. This means that when the market went up, an investor typically made more money than they lost when the market went down.
If you’re currently in your 50s, 60s, or even 70s, you can expect to live for one to three more decades. Hopefully you’ll have enough time to ride out any stock market declines that are likely to happen during that time.
Protect yourself against inevitable stock market crashes
As mentioned above, the downside to living another one to three decades is that it’s highly likely you’ll need to live through a few more stock market crashes during your retirement years. As a result, you’ll want to protect yourself against the time when the stock market crashes, without knowing when it will happen.
The problem is that nobody—not even the so-called experts—has demonstrated that they can accurately predict stock market crashes. There isn’t a reliable red warning light that alerts you the market is about to drop. Similarly, you won’t see a reliable green “go” signal that the market is about to take off.
But there is one thing you can do that will help. History has shown that selling your stock investments during a market crash is one of the worst decisions you can make. Most people who do this lock in their losses, and then they miss out when the stock market recovers. So the best thing is to resolve not to sell when the market declines.
Given these observations, how can you construct your portfolio of retirement income to help it withstand market volatility? You’ll want to balance your need to sleep well at night with the ability to boost your retirement income through positive returns in the stock market. To achieve this balance, build your retirement income portfolio in a way that allows you to ride out future stock market crashes, whenever they might occur.
Start by developing sources of retirement income that won’t drop when the market crashes; these sources should cover the cost of your “needs,” or at least come close. Such sources include Social Security, a pension if you’re lucky enough to have one, and cost-effective annuities you can purchase from an insurance company.
Once you’ve developed enough sources of guaranteed retirement income to cover your basic living expenses, hopefully you should feel confident enough to invest your remaining savings significantly in stocks to give your money the potential for growth. This part of your savings can be invested in low-cost target date funds, balanced funds, stock index funds, or real estate investment trust (REIT) mutual funds.
Then, use these savings to generate a regular retirement paycheck through a systematic withdrawal plan that covers the cost of your “wants”—hobbies, travel, gifts, and spoiling the grandchildren. When the stock market crashes, be prepared to reduce this retirement paycheck—and the money you’re spending on “wants” —while you’re waiting for the market to recover.
If you put this type of plan in place, then, when the market crashes, you should have the patience and confidence to keep your investments in place and ride out the crash. Spend the time necessary to design a thoughtful retirement investing strategy, and you’ll be able to enjoy your life in retirement.