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>Market Volatility & Retirement
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Market Volatility and Your Retirement: Can Timing Alter Your Plans?
For most investors, market volatility is a fact of life. Stock
prices fluctuate from day to day, and markets ebb and flow over
time along with the economy and business cycle. Those saving for
long-term goals can usually overlook temporary volatility in the
interest of long-term gain. But for retirees, who increasingly rely
on their investments to fund their living costs, market volatility
can mean the difference between living comfortably and just
scraping by. In fact, retirees are particularly vulnerable to
market downturns, especially in the early years of retirement,
because of their dependence on portfolio income, their limited
investment horizon, and their need to make sure their savings last
throughout their retirement.
To better understand how market volatility can affect the
longevity of your retirement nest egg, consider the following
hypothetical example. The chart below shows three different
investment scenarios, each of which assume rate of 3%
inflation.
- In Scenario #1, Mr. Jones' investments got off to a shaky start
with three straight years of negative performance. When he factors
in his 7% annual withdrawals, in addition to the poor performance,
he will have depleted almost half of his nest egg in just 10
years.
- In Scenario #2, Mr. Jones experienced a steady 6% rate of
return over 10 years. After factoring in his 7% withdrawals, his
portfolio would be worth considerably more after 10 years than in
Scenario #1 -- $373,895 versus $229,109 -- but such consistent
market performance over an extended time period is
unrealistic.
- In Scenario #3, look at what could have happened if Mr. Jones
had experienced positive returns early in retirement and hadn't
experienced investment declines until much later. As the chart
indicates, his portfolio would have come much closer to retaining
its original principal value -- $479,744 -- despite his annual 7%
withdrawals.
|
Scenario #1 |
Scenario #2 |
Scenario #3 |
Age |
Year |
Rate of Return |
Negative Returns First* |
Rate of Return |
Flat Rate of Return* |
Rate of Return |
Positive Returns First* |
65 |
1 |
-7.0% |
$430,000 |
6.0% |
$494,991 |
16.1% |
$545,700 |
66 |
2 |
-7.0% |
$363,850 |
6.0% |
$488,632 |
16.1% |
$597,508 |
67 |
3 |
-7.0% |
$301,249 |
6.0% |
$480,809 |
16.1% |
$656,575 |
68 |
4 |
9.2% |
$290,718 |
6.0% |
$471,404 |
9.2% |
$678,734 |
69 |
5 |
9.2% |
$278,072 |
6.0% |
$460,287 |
9.2% |
$701,785 |
70 |
6 |
9.2% |
$263,080 |
6.0% |
$447,321 |
9.2% |
$725,775 |
71 |
7 |
9.2% |
$245,491 |
6.0% |
$432,361 |
9.2% |
$750,754 |
72 |
8 |
16.1% |
$241,970 |
6.0% |
$415,249 |
-7.0% |
$655,156 |
73 |
9 |
16.1% |
$236,590 |
6.0% |
$395,820 |
-7.0% |
$564,958 |
74 |
10 |
16.1% |
$229,109 |
6.0% |
$373,895 |
-7.0% |
$479,744 |
Avg. Annualized
Return |
6.00% |
|
6.00% |
|
6.00% |
|
Value at End of 10
Years |
|
$229,109 |
|
$373,895 |
|
$479,744 |
*Based on $500,000 beginning portfolio balance |
Source: SS&C Technologies, Inc. This example is
hypothetical and is for illustrative purposes only. It assumes a
6.0% average annualized rate of return, rounded to the first
decimal, and 7% annual withdrawal based on the first-year
principal, adjusted thereafter for 3% inflation each year. Actual
results will vary. Past performance does not guarantee future
results. |
This example points out the importance of timing in relation to
investment gains or losses when you are in the early years of
retirement. Positive returns early on can mean a lifetime of
financial comfort, while early losses can mean running out of money
in the midst of retirement. Unfortunately, the timing of market
losses and gains is something that we cannot control.
Market Volatility -- A Historic Inevitability
How likely is it that a market decline will coincide with your
retirement timing? No one knows for sure. We do know what history
tells us -- that over long periods of time the stock market has
delivered positive returns on an average basis. But we also know
that in the shorter term, stocks fluctuate in response to many
factors.
For instance, through the market boom of the 1990s, personal
investment portfolios were swelling as the stock market soared.
Then the bubble burst in the technology/Internet sector, only to be
followed several years later by the stock market routing brought on
by the financial crisis. During these periods, many investors lost
a significant portion of their retirement savings. Those who were
unlucky enough to be on the brink of retirement -- or worse, those
who were recently retired -- found themselves making radical
adjustments to their retirement plans in order to get by.
There have been many other periods of decline throughout history
-- even though the particular events that triggered them may have
been different. And there will no doubt be more periods of market
decline in the future. Although market fluctuations are a normal
part of investing, they can still pose challenges to investors,
especially those entering or already in retirement. History shows
that the probability of experiencing a bear market -- defined as a
20% drop in stock values -- in any of the first five years of
retirement is 53%.
Strategies for Managing Market Volatility in Retirement
The following strategies can't guarantee against losses, but
they may be able to ease the ups and downs in the market and
contribute to greater peace of mind.
- Keep withdrawal assumptions conservative. When
calculating how much of your retirement portfolio you can spend
each year, be realistic: The amount you have saved and the expected
length of your retirement will dictate the annual withdrawal
amount. Using historical market performance as a guide, retirement
experts suggest withdrawing no more than 5% of a portfolio's value
each year. This approach may help maintain a cushion against future
market declines while supporting a hypothetical payout schedule of
20 years or more.
- Maintain a sensible asset allocation. Divide
your portfolio among stocks, bonds, and cash investments so that
you have adequate exposure to the long-term growth potential that
stocks provide, but also have some protection against market
setbacks. By spreading your assets across investments that react
differently to various market conditions, you reduce the impact
that any single losing investment can have on your overall
portfolio performance.
- Review and rebalance your portfolio. Once you
have set an asset allocation that works for you, review and, if
necessary, adjust it from time to time to ensure that it still
reflects your needs. Fluctuations in the market may cause your
asset mix to become too heavy in stocks -- which could expose your
retirement nest egg to damaging, even irreversible, setbacks when
you are on the verge of retirement. Similarly, as you grow older,
you may want to "weight" your portfolio more toward bonds for their
ability to produce income.
- Work with a financial professional. The
guidance of a financial professional can always be beneficial, but
it may be especially so in the years leading up to and entering
retirement. It is at this time that investors are at their most
vulnerable to specific market events as well as normal market
fluctuations. In either case, a professional can help investors
make informed, unemotional decisions consistent with their
financial goals.
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An investment vehicle representing a loan to a corporation, government entity, or municipality. Bonds typically pay a fixed interest amount on a predetermined schedule and return their investment principal at maturity. Bonds issued by the U.S. government are backed by the full faith and credit of the United States. Other bonds are backed by the financial strength of their issuers and carry varying degrees of credit risk.
The process of dividing investments in your portfolio among different kinds of assets, such as stocks, bonds, real estate, and cash, to try to meet a specific objective.
The day-to-day (or year-to-year) fluctuation in the value of publicly traded securities and, by extension, broad markets.
A share of ownership in a company, typically traded on one or more exchanges. Owners of stock usually receive voting rights on issues affecting the company and may receive a portion of the company's profits in the form of dividends.
Content is provided by Wealth Management Systems Inc. as a service to Wells Fargo. Copyright © 2021, Wealth Management Systems Inc. All rights reserved.
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