What a bear market means for retirement savings
Joseph Gallagher was starting to think about retiring from his construction job in 2008 when the bear market “beat me up pretty badly,” he said.
Gallagher waited until 2013 to retire. Now, at age 67, he is taking no chances.
Most of Gallagher’s money is parked in a savings account. “There has been too much of a good market the last few years,” says the Manchester, New Hampshire resident.
After being brutalized by the 2008 stock market crash, many people fear a replay could destroy their retirement nest egg.
Bear market losses as extreme as the 57 percent drop from late 2007 to early 2009, are unusual. However, if a long bear market does arrive shortly after a person stops working and starts spending retirement savings, the result can be devastating.
Bear markets occur on average every five years. If a long bear market hits early in retirement, the damage can leave retirees without money for their later years, notes financial planner Michael Kitces.
Most financial planners discourage clients from relying on savings accounts, however, because they rarely last 30 years without some exposure to stocks. But bear markets, and especially a sequence of them early in retirement, can deplete nest eggs, forcing retirement savers to run out of money too soon.
The reason: Retirees usually must pull money from savings each year to cover living expenses. That causes bear market losses to be locked in.
BULL OR BEAR
To understand the impact of bear markets, consider this example of a 65-year-old with $500,000 in savings who retired on Jan. 1, 2000.
A typical planning tool, known as a Monte Carlo simulation, gave the nest egg an 89 percent chance of lasting 30 years if that retiree took out $20,000 the first year of retirement and tweaked withdrawals slightly for inflation each year after 2000, according to a T. Rowe Price analysis.
Monte Carlo computer analysis combines 10,000 different investing periods from history and shows the probability of coming out OK. The retiree would be living within a financial planning rule of thumb: Removing just 4 percent of savings the first year of retirement and then upping it slightly for inflation in the following years.
The “lost decade” beginning in 2000 was an outlier, though. From 2000-2002, the Standard & Poor’s 500 stock index fell about 49 percent. The index lost 57 percent in 2007-2009.
Instead of being 89 percent confident about the future, the chance of being fine in retirement slipped to just 6 percent by March 2009, according to the T Rowe Price analysis.
The original $500,000 nest egg was worth $285,000 – a disaster so early in retirement. Rather than lasting for three decades, the nest egg was destined to be depleted after 22 years.
“I couldn’t imagine living in retirement and seeing your nest egg drop by more than a third,” said Judith Ward, a senior financial planner at T. Rowe Price.
As it turned out, the stock market made a dramatic recovery and would have fixed many portfolios, Ward said.
But people should not count on that kind of luck during a bear market, she added.
When a bear market hits, cutting back spending temporarily is the key. Simply forgoing annual inflation adjustments for three years can help temper the bite of a bear market, according to a T. Rowe Price analysis.
That is why financial planner Mitchell Kraus, of Santa Monica, Calif., gets clients to examine fixed expenses, such as mortgage payments, before retirement begins so they can evaluate whether they would be able to cut back in a downturn.
“If we have a bear market and you have a lot of fixed expenses, you could be doomed,” Kraus said.