The Bear (Market) Necessities
By: Stan Hinden Source: AARP Bulletin Today Date Posted: November 2002
The ferocious bear market that began in April 2000 has been a costly and unnerving experience for millions of investors. But it's been especially traumatic for older Americans. Through it all, they've collectively lost billions of dollars in retirement savings.
The stock market, history shows, moves up and down in cycles. Bull markets are followed by bear markets, which in time give way to new bull markets. That's why most financial advisers tell investors to stay focused on the long term, to avoid panicking over falling prices. "Ride it out," they say. "The market will come back."
That may be sensible advice for younger investors who won't face retirement for many years. They can wait for stock prices to rebound—whenever that might be.
But the advice may not make as much sense for older investors—those approaching or past retirement age. Many of them—especially those within five years of retirement—may feel that they don't have time to wait for the stock market to climb back to where it was.
If you're among them, experts say, you need an investment strategy that encompasses two main goals: first, protecting your retirement savings, and second, providing a certain level of income in retirement.
The easier part of the strategy is safeguarding your nest egg by diversifying your investments. The harder part is making sure that your money doesn't run out after you retire. Your success depends not only on what your investments earn but—more important—on your lifestyle and on how much money you take out of your retirement savings each year.
HOW MUCH? HOW SOON?
How much should you withdraw each year from your retirement savings for living expenses? For most retirees, says Todd Cleary, vice president for financial planning services at T. Rowe Price Group, Inc., that's the most crucial decision of all.
"Cash-flow planning is even more important than investment planning," Cleary says. "It is the most critical thing you can do."
A relatively safe withdrawal rate, he says, is 4 to 5 percent of assets in the first year of retirement. "Once you go much over that," Cleary cautions, "you have to start worrying about the possibility of outliving your money."
Most retirees, Cleary says, also need an emergency fund big enough to cover at least two years of living expenses. The fund—kept in a money market account—is a financial backstop for health or other emergencies but also can reduce the need to sell investments at a loss in a down market.
Retirees, Cleary adds, should make every effort to reduce their living expenses so that they can limit their withdrawals from savings—especially if they are retiring into a bear market climate. [Review our list of fundamental strategies to reduce living expenses and to save.]
SPREADING IT AROUND
The next most important decision for retirees is how to diversify their retirement savings. "Diversification" is a fancy way of saying, "Don't put all of your eggs in one basket."
Financial planners advise having different kinds of investments to achieve different purposes: stocks for growth, bonds for income and money market funds for safety, for example. A diversified portfolio is the best protection from market volatility.
Even with the current decline in the stock market, most financial planners still say that retirees should keep from 40 to 60 percent of their money in stocks and stock funds and the balance in bonds or bond funds.
This advice is based on the view that because the typical retirement period is 15 to 20 years, retirees need the long-term growth that they can get from stocks.
A staunch advocate of investing in stocks for growth is Mary A. Malgoire, a fee-only financial planner in Bethesda, Md. She prefers to see her clients keep most of their assets in stocks. "We are trying to keep clients at 60 percent, even the 75-year-olds," she told the AARP Bulletin.
Financial planners are in a tough spot, Malgoire says. Many retirees need to withdraw money for living expenses. But selling stocks at a loss is not a good option and, with interest rates at all-time lows, it's difficult to find acceptable alternative investments.
Thus, Malgoire says, the emphasis has to be on achieving growth and on limiting the amounts withdrawn from retirement accounts by trimming expenses. "If you can get by with 1 to 2 percent from the portfolio," Malgoire says, "you can afford to ride it out."
THE RIGHT MIX FOR RETIREMENT
A diversified portfolio is a combination of stocks, bonds and short-term investments geared to an investor's age and other personal circumstances. How can an older investor find the right mix?
There's no one-size-fits-all answer. Your choice depends on your circumstances—and your tolerance for risk. But this is no time to stay on cruise control, and a financial planner should be able to help you settle on an "asset allocation" formula that's right for you.
Most financial services firms have free worksheets and other planning materials that help investors devise an asset allocation strategy based on their risk tolerance and intended retirement timeline.
T. Rowe Price, for example, has developed a series of recommended portfolio mixtures for retirees at various ages—55, 65, 70, 75 and 85. [See chart.] The basic principle: As you grow older, reduce your exposure to stocks and put more of your savings, for security, in bonds.
Chart by Juan Velasco/5W Infographics USAThe firm's recommended allocation for 55-year-olds is 60 percent in stocks, 30 percent in bonds and 10 percent in cash or cash equivalents, or 60-30-10. For 65-year-olds, it's 47-37-16; for 70-year-olds, it's 40-40-20; for 75-year-olds, it's 25-40-35; and for 85-year-olds, it's 5-25-70.
In good markets and bad markets, many planners believe, the key to investment safety and success is to diversify well. "It sounds basic in terms of advice," Cleary says, "but it really is the best thing."
Stan Hinden is the author of How to Retire Happy (McGraw-Hill, 2000).
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