Back in November 1972, the Dow Jones Industrial Average wrapped up the month just over the 1,000-point mark, marking a significant milestone. However, things took a downturn, and for the better part of the following decade, the Dow languished. While the stock market seemed stagnant, the world was anything but still.
During this period, significant events and innovations marked society. We witnessed the launch of the first U.S. space station and shuttle. The Watergate scandal grabbed headlines, ran its course, and left its mark on political history. The world mourned the loss of cultural icons like John Lennon and Elvis Presley. On a brighter note, technological advancements took off with the advent of video players and personal computers, while a young Bill Gates laid the foundations for Microsoft. Like many others, I was living through these changes, moving from junior high to my college graduation.
As the calendar turned to 1982, after a long decade, the Dow finally climbed past the 1,000-point threshold again, as it began its rise to new highs.
Retirement back in the ’70s looked quite different. Pensions were widely common. But if one relied solely on investments during that time, it would’ve felt interminably long and could potentially devastate unprepared portfolios.
For those just starting their retirement, enduring a prolonged bear market is a nightmarish scenario, one that puts your nest egg at risk with little chance of recovery. It’s happened before, and there’s no guarantee it won’t happen again. So how does one brace for it?
Retirement Cash Flow
In previous discussions, I’ve delved into evaluating your retirement income and your expected expenses—crucial elements as you embark on the retirement journey. Think of it like choosing a car and knowing how efficient it is with fuel. But, just like any road trip, you need more than just a vehicle; you need awareness of your surroundings.
Modern retirements often require dipping into investment portfolios to cover expenses not met by fixed income from pensions, annuities, or Social Security. Some are fortunate to rely entirely on these guaranteed sources, but the majority of us have to consider when to liquidate investments.
Over the years, studies have repeatedly shown the futility of trying to time or outguess the stock market consistently. Sure, some manage it occasionally, but no one outscores the market over long periods. Even those few, like Warren Buffett, are nearly impossible to predict or emulate beforehand!
From my research into optimal retirement withdrawal tactics, there’s a noteworthy strategy in aligning the sale of assets with broader market cycles: sell stocks when they’re peaking and switch to bonds when stocks drop. Historical simulations back this tactic for long-term benefits. However, its success hinges on having the right asset balance to sell them at opportune times, avoiding forced sales of undervalued assets.
Economic Cycles
Economic cycles tend to roll over every decade, but they are notoriously unpredictable, with each having its nuances. Tools like Robert Shiller’s Cyclically Adjusted Price-to-Earnings ratio (CAPE) give us an approximate yardstick for our current position in the economic cycle, allowing us to gauge asset valuations relatively.
We also have data charting the historical length of these cycles. This data helps form educated guesses about managing retirement assets wisely.
For retirees reliant on investments, this level of precision suffices. Markets don’t shift gears overnight—they transition through phases over time. Therefore, financial decisions seldom require urgency. Even in the rare case of rapid market shifts, a balanced, passive investment strategy eliminates the need for panic.
The pivotal decision in retirement is consistent: Do I need cash, and where will I draw it from? Which assets are suitable for liquidation at this juncture? Understanding your position in the market’s cycle for major asset classes aids in making this call. While there’s no perfect marker, recent research points to the potential of leveraging the CAPE metric to make strategic asset withdrawals.
Bear Market Data
So, how long do these market cycles truly last? How long might you need to depend on your safe cash and fixed-income reserves to survive a market downturn during retirement?
Thankfully, we have robust historical insights into the duration of business cycles and downturns. Data from the Schwab Center for Financial Research outlines recent recovery periods for the S&P 500 Index, with the average rebound time to previous highs clocking just over three years.
But averages don’t capture the full story. In retirement, we need to consider worst-case scenarios. How severe can a downturn be? Wade Pfau’s studies into historical market declines exceeding 50% shed light on recovery durations. They reveal that, for both U.S. and global portfolios, the average bounce-back from the nadir in worst-case scenarios took about nine years.
Furthermore, the National Bureau of Economic Research (NBER) tracks business cycle lengths, providing data that, while not identical to market cycles, run parallel. From 1854 to 2009, NBER data indicates that peak-to-peak business cycles averaged about 56.4 months, or slightly less than five years.
Defensive Asset Allocation
These statistics demarcate crucial timelines for liquidating retirement assets. To decrease the risk of selling stocks at a loss, you must align your conservative asset allocation appropriately. Multiply your required annual retirement income by these years to determine how much to reserve in cash and bonds.
The takeaway? To weather a typical downturn, retain three years’ worth of expenses in cash. For a severe downturn, keep nearly ten years’ worth in cash and bonds. These are the assets poised to hold their value through prolonged slumps.
Interestingly, these recommendations closely mirror my own portfolio allocations, contributing to my ease amidst market fluctuations. No one knows the surprises the next decade will bring. However, with a diversified allocation, you can feel confident about maintaining your lifestyle through retirement.
Valuable Resources
Explore top-notch retirement calculators to perform intricate simulations, including tax strategies, healthcare cost projections, and optimized withdrawal strategies. Our partners, recognized as leaders in this domain, can help you navigate your financial future effectively.
Signing up for a free Empower account allows you to keep track of your assets, performance, and expenses. Also, delve into our books for deeper insights into reaching retirement sooner and making informed decisions on financial independence.
[Darrow Kirkpatrick, founder of CanIRetireYet.com, retired at 50 thanks to a frugal lifestyle, disciplined savings, and simple passive index investing. His insights have been featured in The Wall Street Journal, MarketWatch, Kiplinger, The Huffington Post, Consumer Reports, and Money Magazine, among others. His acclaimed works include “Retiring Sooner: How to Accelerate Your Financial Independence” and “Can I Retire Yet? How to Make the Biggest Financial Decision of the Rest of Your Life.”]
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