We hear a lot of the same questions over and over. It tends to happen when you’ve been in business as long as we have and you’ve helped as many retirees and soon-to-be-retirees with their planning as we have. We thought it would be a good idea to answer a couple of these questions every week.
Please note this very important fact. Our answers do not take into account your particular investment objectives, financial situation, or risk tolerance and may not be suitable for all investors. Our answers are not financial advice and should not be taken as advice. This material is provided for educational purposes only.
How do I stress-test my retirement plan for a recession or a bear market?
The question, “How do I know my retirement plan can survive a recession or bear market?” or some variation of it is one of those questions we typically get in that first meeting. A future client has an idea in their head about what they will do, but there’s typically a lot of what-ifs and gray area that they don’t have an answer for. The short answer is this: your retirement plan should be built for all possibilities. A solid retirement plan should already assume that downturns will happen because they most assuredly will.
Markets don’t move in straight lines. If you’re retired (or close to it), a prolonged downturn early in retirement can create what’s called “sequence of returns risk”—meaning bad returns at the wrong time can permanently damage your income plan. You don’t want to run out of money before you run out of time.
So what does stress-testing your retirement plan look like?
When we’re looking at what to do when the market moves downwards, we’re looking at a few key variables. How much do you have in the market? How many years of cash or conservative assets do you have set aside? How much can you afford to withdraw in a down cycle? Do you have guaranteed income sources (Social Security, pensions, etc.) that you can pull from?
If your income plan only works when the markets are movingup, it’s not really a plan. It’s a bundle of hope.
When we stress test a plan, we run historical scenarios. What would your portfolio have done during 2008? 2000–2002? 2020? Then we look at what your income would look like if you’re down 20-30%. We see if your planned income streams can continue without permanently draining principal? And we absolutely make sure you have enough to keep the lights on—no running out of money for essentials, and we make sure your discretionary spending can remain discretionary, and that you can show discretion in down times.
The goal isn’t to eliminate risk. That’s not possible. The goal is to make sure that if the markets experience a recession or bear market early in your retirement, your retirement plans don’t go down with it.
Can I afford to travel or spend more early in my retirement?
We’re back to that age-old retirement question: “How much can I afford to spend?”. Truth be told, anyone can retire and spend however much they like. How long they can afford to do that will vary. For some, it will be years. For others… minutes.
“Can I afford to travel more early in my retirement?” is a question we love to answer, because the answer is usually yes. When you first retire, you’re still relatively healthy and you have your bucket list with nothing crossed off. These early years are what we call the “Go-Go” years. You’ve spent forty years working hard and saving; these early years are the time to enjoy the fruits of that labor while your health and energy are at their peak.
But understand that your retirement isn’t a static, thirty-year block of identical spending. Most retirees follow a “spending smile” pattern: they spend high in the early Go-Go years (travel, hobbies, home renovations), they stop spending as much in the middle Slow-Go years as things slow down, health issues creep up, and energy wanes, and then spending ticks back up later in the No-Go years as healthcare costs increase and things like continuing care become topics of discussion. If you wait too long to take that dream trip to Europe or buy that RV, you might find that you have the money but no longer have the “Go-Go” energy to enjoy it.
However, before you decide to book the tickets, make sure your retirement income plan is up to snuff.
- Do you have your bases covered? Do you have enough guaranteed income to cover your essentials?
- Sequence of Returns Risk: If the market drops 20% in your first year of retirement, can you still afford that big trip without eating away too much of your investment principal?
- Inflation Risk: Not only will that $10,000 vacation today likely cost $15,000 or $20,000 a decade from now, but all your household expenses and medical care will be higher as well.
- Longevity Risk: You don’t want to have a world-class “Go-Go” decade only to face a “No-Go” decade where the cupboard is bare.
When we develop income plans for our clients, we sort their funds into “buckets”. Now money, Later money, and… if there’s enough left after Later… Never money that goes to friends, family, and loved ones once our client no longer needs it. And we make sure that Now money includes all the essentials plus the fun discretionary stuff that varies from client to client—like trips abroad, fun hobbies, and even basic discretionary items like meals out with friends.
Plans differ. Goals differ. Finances differ. If you want to see if your plan can handle a few extra stamps in your passport, give us a call.