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Personal Finance

Don't Let a High-Flying Market Draw You Into a Premature Retirement

A recent study finds pre-retirees are more likely to stop working near a market peak, leaving them vulnerable to downturns that could reduce savings longevity.

Anyone planning for retirement is aware of the importance of benchmarking the amount needed to leave the working world. But what is less often considered is the importance of timing in the retirement decision and the harmful effect that retiring just before a market downturn can have on the long-term viability of your nest egg. Dr. Rui Yao, an assistant professor of personal financial planning at the University of Missouri, recently co-authored a study that found that retirement rates among retirement-eligible Americans increase as the number of consecutive years of market gains increases. She responded to questions from by email.

You say it is better to retire during an economic downturn than when the economy is booming, as long as you have enough money saved to do so. Why is this?
First of all, it is not my intention to advise people to retire during an economic downturn. When to retire depends on a lot of factors.

People tend to have a target amount for adequate retirement wealth and decide to retire when that amount is reached. If retirees plan to at least partially participate in the market (that is, keep some investment assets), then retiring at a market peak is not a wise choice. The probability of retirement wealth experiencing a market correction is higher when the market is at its peak. The sequencing of returns proves that the earlier the retirement portfolio experiences low or negative returns, the more the retirement income longevity will be affected if annual withdrawals are not adjusted downward and no additional resources are obtained. Reaching a target savings amount when the market is at its peak does not provide the same amount of security for the longevity of retirement income as reaching a target savings amount when the market is down.

However, if retirees plan to cash out all investments and park the assets in a cash/cash-equivalent account or purchase a financial product that guarantees the length and amount of retirement income (such as an annuity), then retiring at the market peak might be a great choice. Given the statistics on longevity and retirement ages, today's retirees spend a long time in retirement. Cashing out investments at retirement might be good for some people but not all.

The idea of retiring during a downturn is counterintuitive for many people because it involves quitting after your nest egg has lost value. How can soon-to-be-retirees know when the time is right?
The market will go up and down regardless when people retire. People who retire based on retirement wealth reaching the target amount have two choices: watch their nest egg lose value before retirement (that is, value falls below the target amount) when they have an opportunity to make up for the loss (such as working longer and saving/investing more); or watch their nest egg lose value after retirement and not be able to do much about it. The key is to know that the target amount of retirement wealth will likely be there even when the market is not doing well.

This target amount for adequate retirement wealth will be first achieved in an up market. When the stock market goes down, retirement portfolios with stock market wealth will go down in value, increasing the risk of outliving retirement resources. The decline in wealth would induce retirees to go back to the workforce. Job re-entry is more difficult in down markets when unemployment rates are high. For retirees who have started collecting Social Security benefits, the amount they can make without losing their Social Security benefits provides a further constraint on how much they would like to work even if they could successfully return to the workforce.

What role does asset allocation play in your research? Are investors with smaller equity stakes more immune to the risks of retiring just before a market peak than those with larger equity holdings?
Yes. However, not participating in the market just to avoid such risk may be unwise. It would incur an opportunity cost, which is the return not earned due to giving up the opportunity to invest.

What about other factors such as life expectancy, when you take Social Security, and whether your spouse will continue to work? Do these have any bearing on your approach to retirement timing?
Life expectancy is an unknown factor but plays an important role in retirement planning. Controlling for other factors, including desired consumption level and income from Social Security and pensions, people who expect a longer life during retirement should accumulate more wealth before they retire.

In our survey on retirement patterns, those whose spouse was retired were more likely to retire than all other household types, including those whose spouse remained in the labor force, those whose spouse was not working at the time of interview, and those who did not have a spouse. This result indicates that, among married individuals, leisure is complementary. Family preferences make it reasonable that married couples coordinate their retirement decisions and retire around the same time. However, people who retire at the same time also need to be more careful in planning for retirement. If both spouses decide to retire close to the end of an up market, the household would have no cushion should their retirement portfolios be hit by a negative return. With this said, I do not have an intention to advise couples to retire at different times since it is a personal preference and money is not the only source of happiness. My advice to them is to be more careful in planning when to retire, if they want to retire together.