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It’s a scary time for new retirees.
Stocks have plunged this year. Bonds, which traditionally serve as a ballast when stocks falter, have also been pummeled. Both trends are worrisome for seniors who rely on investments for their retirement income. high inflation also means retirees need to draw more income to afford the same items and make ends meet.
“That’s a pretty bad combination that’s relatively rare,” David Blanchett, head of retirement research at PGIM, the investment management arm of Prudential Financial, said of this three-pronged challenge.
“2022 has been a dangerous time to retire,” he added.
However, there are steps retirees — and those planning to retire soon — can take to protect their nest egg.
the S&P 500 Index is down nearly 17% in 2022. The index fell into a bear market at one point Friday (meaning the US stock index declined over 20% from its recent high point in January) before recovering a bit.
The Bloomberg US Aggregate Bond index is also down about 9% this year. Bond prices move opposite interest rates, a dynamic that has stressed bond funds as the Federal Reserve raises its benchmark rate†
Investors are most vulnerable to market shocks in the early months and years of retirement.
This is due to “sequence of returns” risk. Someone who withdraws money early in retirement from a portfolio that’s declining in value is at greater risk of depleting their nest egg too soon, relative to a retiree who suffers a market downturn years later.
When the market pulls back, it means investors need to sell more of their investments to generate income. That depletes savings faster and leaves less of a growth runway when things rebound, hobbling a portfolio intended to last several decades.
The “sequence” — or timing — of the investment returns is what’s important.
Consider this example from Charles Schwab of two new retirees with $1 million portfolios and $50,000 annual withdrawals (adjusted for inflation). The only difference is when each experiences a 15% portfolio loss:
One has a 15% decline in the first two years of retirement and a 6% gain each year thereafter. The other has a 6% annual gain for the first nine years, a negative 15% return in years 10 and 11, and a 6% annual gain thereafter.
The first investor would run out of money after 18 years, while the other would have about $400,000 left.
“If you’re planning for 30 years [of retirement]those first few years could be really important in terms of what you end up experiencing for your outcome,” Blanchett said.
Of course, some retirees are more vulnerable than others.
For example, a retiree who gets all or most income from Social Security, pensions or annuities is largely unaffected by what’s happening in the stock market. The amount of those funds is guaranteed.
Also, sequence-of-returns risk is likely less consequential for someone who retires at an older age, because their portfolio won’t need to last as long. Nor is it likely to greatly affect a retiree who has saved far more money than needed to fund their lifestyle.
If new retirees are nervous given the current market situation, there are a few ways they can reduce their risk.
For one, they can pull back on spending, thereby reducing withdrawals from their nest egg. An adherent of the “4% rule” strategy might opt to forgo an inflation adjustment, for example — though there are many different schools of thought relative to spending in retirement.
Whatever the strategy, reducing withdrawals puts less stress on the investment portfolio.
“Does it mean you can’t take a fun cruise or vacation? Not necessarily,” Blanchett said. “It requires thinking more about tradeoffs, potentially, based on how things go.”
Similarly, retirees can restructure where their withdrawals come from. For example, to avoid pulling money from stocks or bonds (categories that are in the red this year), retirees can pull from cash instead.
This gets back to sequence risk and trying not to pull money from assets that are down in value. Drawing from a cash bucket while waiting for other assets to (hopefully) recover helps achieve that.
“You don’t want to be selling stocks or bonds in this environment if you can’t afford not to,” said Christine Benz, director of personal finance at Morningstar.
Retirees may not have several months or years of cash handy, though. In this case, they can pull from areas that haven’t been hit as hard as others — for example, perhaps from short- or intermediate-term bond funds, which are less sensitive to rising interest rates.
Workers who haven’t yet retired (and who are worried about having enough money to do so) can opt to work a bit longer, to the extent they’re able. Or, they can think about earning some side income once retired to put less pressure on their nest egg.
Reducing demands on your investment portfolio is one of the most important things you can do, Benz said. For example, Social Security recipients get a guaranteed 8% annual boost to their benefits each year they delay claiming past full retirement age† (That 8% boost stops after age 70, though.) Seniors who can delay get a permanent bump in their guaranteed annual income.