I was having a conversation with a client the other day who was feeling nervous about the state of the share market. This guy has been a client for many years so is quite experienced in terms of the ups and downs of market volatility, but as he is approaching his desired retirement date, for some reason this was a day when the media reports had finally got to him.
He was worried that having been throughout the downturn of the GFC, a significant negative impact on markets was going to have a major impact on his retirement plans. “I don’t have enough time to recover if something bad happens” to use his words. He had heard many stories of how people had found themselves unable to retire when they wanted to the last time around and he didn’t want it happening to him this time.
This client has substantial investment assets so would likely be OK if his portfolio did fall 20 or 30% but he was sufficiently concerned to call me for a chat. The conversation highlighted for me a misconception that many pre-retirees have, that the point of retirement is the end of their investment life. Whilst the funds you accumulate for retirement is measured in dollars, and we as financial planners often prepare projections to achieve a number which will provide sufficient income to satisfy our client’s desired retirement lifestyle, in the end it is just that, only a number.
To illustrate the status of the number, we need to look at how we use it when calculating the adequacy or otherwise of a retirement nest egg. When preparing these kind of projections we will take the number and multiply it by a rate of return to work out whether sufficient income from an investment portfolio can be expected to fund the kind of retirement that the client wants. Regardless of the client’s appetite for risk, either before or after retirement, this rate of return will usually be higher than the rate offered by cash (the only risk free investment). The implication is that the funds are going to be invested in some way, i.e. the client’s investment life will continue post the time when they are no longer earning income from their labour, and are instead relying upon that which they have accumulated.
What this means is that even if there is a negative period in investment markets, the majority of your accumulated finds are going to remain invested, and will have the opportunity to recover, even while you are retired, provided you have accumulated enough. We project based upon relatively conservative rates of return over the long term recognising that in some years returns may be lower than in others – some years may even be negative. Conversely there will be years when returns will exceed our projected rates, and it is these years which allow your retirement nest egg to recover.
The thing is that a retirement number is a target, a goal, a mechanism by which we can measure success. It is not necessary tha the number be available on the day of your retirement. If you have achieved your number a couple of years out, and there is a downturn in the value of your portfolio before you have retired, unless there is a significant drawdown on the value of your investment at the point of retirement, given time it will recover. Similarly if you have the number when you retire, but there I a market downturn shortly thereafter, you probably won’t need to go back to work – if the number is sufficient. The pattern of drawdowns is crucial.
Where we saw the worst effects on people’s retirement plans leading up to the GFC, and in other downturns, is where people were relying upon access to their retirement accumulation funds to pay down debt or some other lump sum expenditure. In this instance, a defined need for cash at the point of retirement, meant that funds were no longer going to be invested, were in fact going to be turned into cash at that time and would not have the opportunity to recover should something bad happen.
The key to successfully avoiding the worry that impending retirement plans will be adversely affected by a sudden market downturn is to pressure test your accumulation fund for a period of negative returns. To do this you need to work out how much you will need to withdraw, both at the time of retirement, and on an ongoing basis, allow for a relatively conservative rate of return over a long period on the funds that remain, and recognise that investing is for the long term whether you are retired or not.
Retirement is a door not a brick wall. It is a beginning, not an end. A robust retirement plan allows for market volatility, and takes into account both upside and downside. Professional help in working out what will best work for you is always available, this is what we do for a living.
The views expressed in this article are my own and have no official standing whatever to the living or the dead. If you like this article why not share it? I appreciate your support. Be sure to visit our blog again for this and other articles. If you have any thoughts, comments are always welcome! Why not connect with me on Social Media so we can continue the conversation.