If you’ve been watching your retirement portfolio over the past few months, you’ve probably noticed that the value of your nest egg has dipped dramatically. From the start of 2022 to November 2, the S&P 500 fell more than 21%, the Dow Jones fell more than 12% and the Nasdaq fell nearly 33%.
And the stock market isn’t the only aspect of the economy that could hurt soon-to-be retirees. In recent months, inflation has remained at record-high levels. The Fed has responded by raising interest rates and predicting a global recession as companies and consumers cut back on buying and borrowing in response.
As people look to their future retirement, it seems less than optimistic. If you’ve spent the last few decades of your life saving money for your golden years, the recent market downturn doesn’t mean you haven’t tried.
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Saving for retirement 101
Most people have three primary sources of income in retirement: individual retirement accounts (401(k)s and IRAs), pensions, and Social Security.
However, most people rely primarily on income from their retirement accounts. Most personal finance experts recommend saving in both a 401(k) and an IRA. Traditional IRA or Roth IRA. Choose Charles Schwab, Fidelity Investments, Vanguard and Betterment as companies that offer some of the best individual retirement accounts.
Most companies no longer offer employee pensions, and Social Security typically replaces only a small portion of people’s pre-retirement income. According to the Center on Budget and Policy Priorities, the average person with lifetime earnings earns only 37% of their pre-retirement income through Social Security benefits. This means that the responsibility of saving for retirement falls entirely on the individual.
In general, personal finance experts recommend that retirees aim to save 25 times their annual living expenses. In other words, a person with $40,000 in annual living expenses should aim to save $1 million for retirement. In retirement, an individual can withdraw no more than 4% of their retirement capital annually when adjusted for inflation.
However, this rule is falling out of vogue as people live longer and the cost of living increases. Because the 4% retirement rule is based on assumptions about how long people will live, capital allocation, and historical market returns, it is not a one-size-fits-all rule.
“This is why planning is so helpful, so you don’t have to use rules of thumb,” says Douglas Bonepart, president of Bone Fied Wealth.
In fact, Richard Sias, a finance professor at the University of Arizona, recommends a lower rate of return. They found that people would need to withdraw 2.26% of their portfolio (assuming a 60/40 stock and bond allocation) to have a 95% chance of success. In other words, if you withdraw 2.26% of your retirement nest egg annually, you have a 1 in 20 chance of running out of money before the end of retirement.
And if you’re worried about how the recent market downturn will affect your withdrawal rate, researchers looked at history to see how seniors fare when retiring in a bear market. T. Rowe Price looked at the retirement portfolio performance of people after retiring during the bear markets of 1973, 2000 and 2008, finding that portfolio values eventually recovered or exceeded their original value 10 years later.
Researchers note the importance of flexibility in response to market downturns. Retirees should use a withdrawal rate that changes based on factors such as inflation, market fluctuations and changes in personal spending to ensure long-term success.
Is it time to change your portfolio’s allocation?
If you manage a diversified retirement portfolio devoted to 60% stocks and 40% bonds, you’ve probably noticed that both asset classes take big hits. From the beginning of the year to the end of September, the value of the 60/40 portfolio 20% has fallen.
And there’s no expert consensus on what you should do with your portfolio.
If you’re a skilled investor, Bonparth suggests taking advantage of current dips by buying stocks or stock funds when they’re low. But of course, if the market hasn’t gone down yet, you’re taking a risk.
“The reality is that the market will probably fall more,” says Mark Pitre, principal at Financial Advisors of California. “Because we believe there is a good chance of rebalancing in the next year, two years or three years.”
And since interest rates are inversely related to bonds, it’s not a good idea to pour all your money into bonds. When interest rates rise, bond prices fall, so the Fed’s upcoming rate hike means that existing bonds will be worth less in the future.
Shannon Sakosia, chief investment officer at SVB Private, recommends that investors avoid making big changes in their portfolios without consulting a financial planner and try to stick to their long-term financial plan.
The bottom line
Most importantly, there is no one-size-fits-all advice for investors nearing retirement. Your retirement plan needs to take into account many factors, whether it’s how long you want to live or how you want to live Your portfolio is risky. Being flexible in how much you withdraw from your nest egg is key to ensuring long-term success. This means less withdrawals in market downturns and more when the cost of living rises.
And if you’re thinking about changing your portfolio allocation now, you’ll want to make the changes based on your long-term plan. With both stocks and bonds performing poorly, this is not a good time to make significant changes to your portfolio, especially if the market is falling.
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Editorial Note: The opinions, analyses, reviews or recommendations expressed in this article are those of the selected editorial staff only, and have not been reviewed, endorsed or approved by any third party.