Retirement Income in a Down Market

Retirement Income in a Down Market

Whenever the stock market takes a dive or seems to be stalled after a dive, the sharks come out, offering various retirement income solutions. These are almost always sales hype to sell an annuity. Here’s a handful of the Google ads we found:

  • 7 Strategies for More Retirement Income
  • How To “Crash Proof” Your Retirement
  • Guaranteed Retirement Income Strategies
  • Retirement Income Planning Tips
  • Retirement Income Decisions

Each of these leads to an annuity product; none really addresses the key issue – how to safely generate or maintain retirement income and keep up with inflation. We’ll even go further; in our professional opinion, each of these actually significantly hurts your chances of succeeding in retirement.

Don’t Let Fear Ruin Your Day Or The Rest Of Your Life

Down markets create fear. That fear is a legitimate concern if your portfolio is not set up correctly. Too many retirees or soon-to-be-retirees have neglected their portfolios and are in danger of running out of money. But legitimate fear from one mistake (neglecting your portfolio) should not drive you to make the more harmful mistake of buying an annuity to generate “guaranteed retirement income.” Too often, this guaranteed income stream will be insufficient for your retirement and an absolute catastrophe for your family.

Annuities Are Silent Killers

An annuity is generally a contract between you and an insurance company. In exchange for your money (you buy an annuity), they promise to pay you a certain amount (“guaranteed”) for the rest of your life and/or some amount of years you negotiate with them. There are different types of annuities – and for a better understanding of the details, check out our annuity guide here but most often your money will stay with the insurance company after you’ve passed away. During the retirement years, the guaranteed income rarely keeps up with inflation. Most people fall further and further behind, suffering a real deterioration in their living standards during what they hoped would be the golden years.

Retirement Income Properly Understood

Part of the problem here is that “retirement income” is a misleading term as it applies to your retirement. Income is an accounting and tax term. It applies to interest and dividends. What’s missing from the conversation is an appropriate discussion of total return. Total return is the amount you earn on your entire portfolio, including capital appreciation. And capital appreciation is critical to keeping up with inflation.

If you have a $1 million portfolio generating $50,000 in annual retirement cashflow, you better plan on having a $2 million portfolio that generates $100,000 in cashflow at the end of 24 years just to keep up with inflation. That seems like a lot of money, but it’s true. In 24 years, you’ll need to have $100,000 in order to buy the exact same stuff you can buy today with $50,000. The same is true for the principal balance. $1 million needs to double to keep up.

A Plan Is Absolutely Necessary

The very first thing – the most critical thing, really – is to develop a retirement and investment plan which lays out the necessary steps to meet your needs today and tomorrow. If you haven’t done this, or haven’t done it with someone who is 100% objective, your odds of success are very, very low.

How Do You Keep Up In A Down Market?

Let’s say you develop that retirement and investment plan, and then the market drops. How are you going to earn that critical necessary return during a down market? The answer to your future actually lies in the past.

We can look back to a couple of prolonged down markets to see what worked then.

  • 1986 to 1979 – stagflation and a volatile stock market. In these years, there were zero gains in the major stock market indexes.
  • 2000 to 2013 – bursting of the bubble. Stock values dropped from the bubble-highs and spent the next 13 years climbing back up to almost exactly where they started. There was no real appreciation during this period – simply a regaining of what was lost in the downturn.

How we’ve described these periods no doubt leads you to wonder what good could have come out of them or how anyone in retirement could have survived, let alone maintain their living standard. But with a thoughtful portfolio structure, they could have prospered during these tough times.

Investors during the stagflation period could have earned an average return of 5.2%/year. Investors during the post-bubble period could have earned an average return of 5.7%/yr. This may seem too good to be true, but a well-executed program of dollar cost averaging and reinvesting dividends during these periods would have generated these results. Even during periods when the market went nowhere, you can still come out ahead.

The Amazing Power Of Dollar-Cost Averaging

Dollar-cost averaging (DCA) is a process of periodically investing a fairly regular amount into a portfolio. The amount being reinvested can be deposits you’re making on a regular basis or simply taking dividends you’re earning and reinvesting them back into the portfolio. Too often, during retirement, retirees tell their stock broker to put their dividends into cash or money market. That’s the wrong approach.

Making those regular deposits or consistently reinvesting those dividends accomplishes two things:

  • It ensures that your investment holdings are not purchased at inflated prices
  • It ensures that some of them will be bought at dramatically reduced prices

These two benefits together provide the amazing positive return results discussed above. This may seem like a magic trick, but it’s actually a well-documented mathematical reality. You see, each regular deposit or each dividend reinvestment lets you buy more shares of stock when prices are low than you can when prices are high. If done long enough, you’ll have more shares that are purchased at low prices than you have shares purchased at high prices.

The lower-priced shares will generate significant gains when prices return to their original level. Let’s use an example to make sure you really understand it.

If you own a $100 share of stock, and that price falls to $50 in one year and then rises back to $100 in the second year, we can all agree that you have not gained anything on that particular share of stock. But if you purchase a share of that stock when it hit $50, that share will gain 100% when the price comes back to $100. Every time you buy a share at a depressed price, you are setting the stage for massive gains simply by allowing prices to return to their starting levels. Combine all of this together, and that’s how you would have earned 5.2% or 5.7% per year during some fairly long and otherwise disastrous time periods.

Strategies During The Retirement Years

This strategy can work during the retirement years even as you’re withdrawing from the portfolio to sustain your living standard. The key strategy during these years is to fine-tune your portfolio so you have the right combination of stocks AND bonds. The type of stocks and the type of bonds you own also determine how successful you’ll be. Even with all we’ve said above about the mathematical wonder of dollar-cost averaging, it is possible to do it wrong.

Once again, we return to the need for a well-conceived retirement and investment plan. We have to determine what you need for retirement, how those costs will grow with inflation, how much growth you need to keep up with inflation, and then what types of stocks and bonds to purchase. An analogy to medicine here is appropriate.

Hire A Fiduciary Advisor

Don’t try to practice medicine on yourself; you’ll never know enough to heal yourself. You need a doctor who has been trained to diagnose what you need and to prescribe the cure. The same holds true for your investment portfolio. You’ll never know enough to manage this successfully on your own. Trying to do that makes you compete against money managers who live, breathe, eat & sleep investment management. They will win; you will lose.

Instead, engage the services of an objective advisor. The best are those who have achieved a fiduciary status. That means they are morally and legally bound to only act in your best interest. At First Financial Consulting, we are proud of our 45+ year history of objectively helping clients, and we meet that critically important fiduciary standing.

Greg Welborn is a Principal at First Financial Consulting. He works with individuals and privately-owned businesses on financial planning issues including investment, retirement, and tax planning, among others.

Greg Welborn is a Principal at First Financial Consulting. He works with individuals and privately-owned businesses on financial planning issues including investment, retirement, and tax planning, among others.

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