Portfolio Strategies for a Shaky Market
As retirement nears, avoiding major losses is essential
In her head, Gail Hoffmann knows it's too soon to panic. While the recent market sell-off has pushed stock prices down by as much as 10 percent, the Morris County, N.J., marketing manager understands that this is nothing compared with the bear market of 2000-2002, which cut the value of the Standard & Poor's 500 index in half.
And as frightening as stocks can be, as an older baby boomer, Hoffmann knows all too well that she needs equities in her portfolio to keep her money growing over the course of a long retirement.
But in her heart, Hoffmann says she can't help but worry, what with the Dow Jones industrial average swooning 1,000 points or more recently from its highs and with talk of recession creeping back into the headlines. At the very least, she says, "I find myself paying more and more attention to the news on the ride to and from work."
With good reason. While most investors are taught to shut out the day-to-day noise of the stock market—and to invest for the long haul—older boomers like Hoffmann find themselves in a different situation.
While it's true that retirement can last more than 30 or even 40 years, hitting a small speed bump early on in retirement can dramatically shorten your nest egg's life expectancy. For instance, say you had retired at age 65 in 1963, with a $1 million portfolio—half invested in stocks and the other half in corporate bonds. Now let's assume that you tapped $70,000 from this account every year for 30 years. Even after three decades of withdrawals, you'd still be left with $784,000 in your account by the time you turned 95, thanks to rising stock values and the effects of compound interest.
But let's tweak this example slightly. Instead of retiring in 1963, say you stopped working one year earlier, in 1962, while keeping the same mix of investments and level of withdrawals. In this case, instead of having more than three quarters of a million dollars at 95, you'd have run out of money by that age.
Why? Simple. In 1962, the first year you would have tapped your nest egg, the stock market lost about 12 percent. And since you withdrew an additional 7 percent of your original $1 million (or $70,000), your portfolio was reduced by almost a fifth in just your first year out. But in 1963, the stock market rose 19 percent. Instead of losing ground in Year 1 of retirement, your portfolio actually grew to $1.1 million, despite your $70,000 withdrawal.
Bear tracks. It goes to show that "your start point is important," says Philip Cooley, a professor of business administration at Trinity University and an expert in retirement withdrawal strategies. As bad as 1962 was, the year 2000 was even worse for retirees—"probably the worst possible time to choose to leave the workforce," says Cooley, "because you went through three years of the worst bear market in modern history at the same time you were taking money out of your account."