Markets can’t be predicted, but that doesn’t mean you should leave your retirement to chance.
The 10,000 Baby Boomers turning 65 every day in America are asking themselves these questions:
- Can I retire?
- Have I saved up enough money?
- When is the next market crash going to happen?
- If I do retire, am I going to outlive my money?
These questions hold a tinge of panic. The stock market’s record bull-run is affecting everyone, and we can all sense that a crash may be looming. But, for Baby Boomers, the stakes are higher. The number one fear of retirees is not death, it’s running out of money in retirement.
How can we protect ourselves if (or when) the stock market bubble bursts?
The Problem With Stocks
Since the New York stock exchange started trading in 1817, there have been numerous market ups and downs. But, here’s the real kicker: since 1895, looking at daily data, the Dow has spent just 4.32% of its time at new heights. The rest of the time investors were simply making up previous losses.
Even though common sense says the stock market “trends up” through time and may be good for the young investor with a long timeline to retirement, the market runs in 18 year cycles and experiences crashes every 7 to 8 years on average. It’s a dangerous place for retirees to put their money. For instance, we all remember the Great Depression that followed the stock market crash of 1929 from history class. This cycle lasted until around 1946. The years following World War II, 1946 to 1964, were a time of huge economic expansion.
With many ups and downs, cycles, and crashes, fast forward to 2008: thousands of people lost their retirement savings during the Great Recession. It’s been ten years since then, and we are well overdue for another bear market.
The problem is, if you start withdrawing money out of retirement accounts that are fluctuating due to a volatile stock market—which as a retiree you need to do in order to pay your bills—you will run out of money. Think of it like compound interest in reverse. It’s financial suicide.
If you are one of those people who thinks that holding individual “blue chip” conservative stocks (new “hot” stocks) are the way to go, think again. There is something called “creative destruction” or “disruptive innovation” that adversely affects entire industries. Nothing stays the same.
For example, observe Amazon’s 127%+ growth over the last two years versus dying retail stores like Sears (established in 1893), or read this article on CNBC, reporting that as of August 28, 2018, Campbell’s Soup, a stalwart “commodity,” is trading at four-year lows, while GrubHub, an online ordering and restaurant food delivery service, just reached an all-time high. Technology and innovation are what people want right now, but people are fickle. What people want drives stock prices up or down, which is not a safe situation for retirement.
The Problem With Bonds
There is no crystal ball, but many experts predict that the next bubble to burst will be bonds. Trading can, and will, dry up in a heartbeat, right when retirees need to sell in order to create income to live on. Once again, we can look back to 2008, when high-yield benchmarks lost a third of their value within a few weeks. Many individual bond issues lost much more.
Some say the bond market collapse will go deeper and happen faster this time because of many factors, such as Dodd-Frank, TARP, and quantitative easing legislation (in response to 2008) creating an artificial economy worldwide, extremely low interest rates which are being raised by the Federal Reserve, and corporate bonds which may be set to fall to junk bond rating levels because of tariffs and other factors affecting demand. Legal and contractual constraints may force institutions to sell, pressuring all except the highest grade corporate and sovereign bonds. Treasury and prime-rated corporate bond prices will go down, not up, and the selling will spill over into stocks and trigger a drastic bear market.
In the latter part of 2020, at the very latest, the US government debt will be at $40 trillion. There is a lot of tension among financial professionals who are anxiously monitoring all of this. Bonds are just part of the debt that they’re scared about, and some are already selling bonds off.
The Problem With The Rule Of 100
Wait, what? the Rule of 100 says that as I get older, I should have more bonds!
Unfortunately, the Rule of 100 is still being used today. The “diversified” pie chart that bankers and brokers use to put your retirement savings in is split between stocks and bonds (actually bond funds). As you get older, you get more bonds and bond funds in proportion to stocks. The Rule of 100 says that when you’re 60 years old, it’s 60% bonds; 65, 65% bonds; 75, 75% bonds; etc.
The Rule of 100 might have been a good rule to live by back in 1980, when you could get a 15% return on a 10-year treasury bond, but it doesn’t make sense to put 60 to 70% of your assets in something that’s paying around 2% today. You can’t live on that.
Interest rate risk makes bonds and bond funds even more dangerous for retirees. In fact, interest rate risk is at an all-time high because interest rates are at, or near, all-time lows. When interest rates rise, the value of bonds and bond funds goes down.
Bond funds have always been used as an avenue for safety, for a little bit more diversification, and as a safe haven to avoid risk. Today, the opposite is true. If you don’t believe this, all you have to do is look back at recent history. For example, in 1994 when interest rates jumped up from 6% to 8%, according to Morningstar, which is a database for all the mutual funds and bond funds out there, the average bond fund fell by 20% that year. This happened again in 1999 when rates climbed from about 4% to 6%, and the average bond fund ended up falling by 17%.
The Problem With The Pie Chart In Retirement
According to Warren Buffet, rule number one is to never lose money, and rule number two is: “see number one.” Unfortunately, the pie chart won’t help retirees achieve this goal.
Bankers and brokers are trained to use the pie chart for portfolio “asset diversification.” The pie chart breaks down all of your assets into different, primarily mutual funds that are allocated to domestic stocks, foreign stocks, small cap, large cap, etc. The other part of the pie chart is in bond funds—maybe domestic bonds, government bonds, corporate bonds, etc. Whatever the stockbroker or banker’s firm offers for sale.
This strategy may work when you’re young, but, as we’ve pointed out, both stocks and bonds are at risk in the market. Your entire retirement is at risk using the pie chart method. You can “diversify” all you want, but if the market goes down, it all goes down. You run the risk of completely running out of money when you withdraw funds from fluctuating market accounts, because you will be compromising your gains and accentuating your losses.
What You Should Do In Retirement
The whole idea of moving to safety is correct; however, since bonds aren’t safe, you need to find what is safer. Cash is one thing to look at. There are other principal-guaranteed accounts to consider as well.
A retirement planner—not a stockbroker or banker—can help assess the best options for you. A fee-based retirement planner (not a commission-based salesperson) will look at your personal situation and create a custom retirement plan and distribution strategy based on your Social Security benefit (and the best way to optimize it), pensions, other income like real estate rental income, as well as your defined benefit plans (like 401(k)s) which may come with hefty income taxes unless you run the numbers and create a logical strategy to mitigate taxation.
Reliable income, which covers your cost of living and includes cost-of-living increases, is key, and your retirement planner should be looking to put the bulk of your money into principal-guaranteed accounts with guarantees provided by a bank, an insurance company, a municipality, or the federal government. These accounts are not likely to go down in value if the stock or bond markets go down.
NOTE: Variable annuities are actually invested in the stock market, stay away from them. Many income annuities are a bad value. Be sure to work with a fee-based fiduciary who will show you all of the hidden fees underlying various products geared to retirees.
Don’t let the bubble burst on your retirement. Have the foresight to hire the right help.
