Retirement Investing Requires a Change in Approach
Not too long ago, a retirement timeline assumed you lived into your seventies, supported by a pension and Social Security retirement benefits. Today, pensions are almost nonexistent, life expectancies are longer. Further, the desire to provide a legacy for heirs and charity can extend the timeline decades beyond our own lifetimes. Effective financial management in retirement is no longer optional: it’s critical.
Retirement investing is very different from investing before retirement. Before retirement, things are easier. Living expenses and taxes are intended to be covered through employment. Investing is focused on capital appreciation.
Financial market declines and loss of purchasing power due to inflation are much more concerning when using savings and investments to pay for living expenses and taxes – and they need to be dealt with, as these concerns are real.
Multiple Risks to Manage
The transition from one source of income (employment) to a self-directed source (savings) is a critical period of time that can define a person’s future financial stability. If unprepared, and worse, if the timing is not right, moving into a self-directed source of funding just as a bull market collapses can decimate retirement savings.
Long-horizon retirement portfolios call for a multi-faceted risk management approach to satisfy conflicting demands: cash flow needs and wealth protection (for the present) plus capital appreciation (for the future) - taking into account the risks imbedded in the markets, cash flow management, consumption (spending), taxes (income taxes and estate taxes), inflation (loss of purchasing power), legacy desires, and incapacity risk. Add to that list the risk of a spouse or partner who has no interest in finances.
That’s a heavy lift for anyone – even the astute investor.
Market Declines
Every calendar year, without exception, the broad stock market experiences declines that occur within the year (“Intra-year declines”). For example, 2024 ended the year with a solid 25 percent gain but experienced an intra-year decline of 8.4 percent. The year 2022 ended down 18.1 percent but fell further (-25.4 percent) during the 2022 calendar year. At this writing, the S&P 500 TR Index is down 4.3 percent for the first quarter of 2025 (through 3/31/2025); we’ll see if the year ends up or down.
Daily declines are also to be expected. The market’s largest one-day decline (-20.5 percent) since the 1920s was recorded on October 19, 1987, a Black Swan event (an outlier not captured by risk measures such as standard deviation). The 1987 year ended up 5.3 percent.
The next four largest one-day declines of the top 25 occurred in the 1920’s and 1930’s. But in sixth position, is the -9.5 percent decline of March 12, 2020, during the one-month long Coronavirus Bear Market (February 19, 2020, to March 23, 2020). In eighth position is the October 15, 2008, decline of 9.0 percent during the Great Financial Crisis (October 9, 2007, to March 9, 2009).
Sequence Risk
Imagine retiring just as a bear market begins its descent. To recover losses an investor needs a strong upward movement, and time.
Bear markets are measured by a 20 percent drop from the previous peak. “Mega Meltdowns” are bear market drops of more than 40 percent. The most recent occurred during the Great Financial Crisis, when the market fell 57 percent from October 9, 2007, to March 9, 2009. A drawdown of 57 percent called for a gain of 133 percent to make it back to even, which occurred by March 28, 2013, four years after the March 9, 2009, bottom.
Earlier, the Internet Bubble burst on March 24, 2000, dropping 49 percent by October 9, 2002. You needed a gain of 96 percent to recover from the 49 percent decline, which occurred almost five years later on May 30, 2007.
Declines of between 20 percent and 40 percent are “Garden Variety” bears, the most recent being a decline of 25 percent that lasted from January 3, 2022 through October 12, 2022. Breakeven required a gain of 33 percent, which occurred less than two years later on January 19, 2024.
These bear market returns and recoveries are defined strictly by the up and down movements of the market. When retirement portfolios need to factor in funding retirement expenses, downward market periods are even more important to understand, something you or your professional investment adviser would be expected to calculate, manage, and monitor over time on an after-tax and after-inflation basis. If you add a retiree’s withdrawals into the equation, declines are deeper, and recoveries take longer.
Risk is not limited to stock market volatility. Depletion can occur with safe assets as well as more volatile stock market holdings.
For an example of the stock market outperforming, consider the Great Financial Crisis Mega Meltdown. Withdrawing four percent per year for expenses, increasing annually for actual inflation, T-Bills underperformed the S&P 500 Index by far, by a factor of ten. Over the 18-year time span available to us (through 2024), one million dollars invested in T-Bills ended with about $260,000, while the S&P 500 Index ended with over $2.6 million, before taxes.
However, in the preceding Mega Meltdown (Internet Bubble), T-Bills and the S&P 500 ended an 18-year time span with almost identical ending values (about $400,000 after investing $1 million at the beginning of 2000, before taxes).
Preparation Is Critical
In studying bear market declines it becomes clear that the fate of the person who ignores market volatility is at higher risk of potentially depleting assets – it’s better to be prepared.
Portfolio Approach
In retirement, a list of recommended investments no longer satisfies the larger enterprise of managing retirement needs. Now, a portfolio approach is necessary. The term “portfolio” has a special meaning. In the words of Nobel Prize–winning economist and father of portfolio management Harry M. Markowitz, a portfolio is “more than a long list of good stocks and bonds . . . [it is a] balanced whole [that provides] protections and opportunities with respect to a wide range of contingencies.”
The portfolio must be organized to both grow and fulfill cash flow needs.
The portfolio must be managed to meet long-horizon goals. A market-weathering portfolio calls for planning, executing, and, equally important, monitoring progress against goals to provide for sufficient cash flow after taxes while adjusting for changing markets, needs, and circumstances over the decades that comprise the investor’s lifetime – or longer when there are legacy interests, whether family or charity. Very simply, the portfolio strategy and methodology need to flow from your unique situation.
