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What If This Turns Out to Be a Terrible Time to Retire?

Pre-retirees and new retirees concerned about today's markets can take steps to protect themselves.

Workers are feeling pretty confident in their nest eggs, according to the latest survey from the Employee Benefits Research Institute. Roughly three fourths of workers in the 2022 survey said they were at least somewhat confident that their funds would last through their retirement years, up from just 60% of workers who said the same in 2017.

But the same forces that have fueled retirement confidence have the potential to work against new retirees in the years ahead. A 2012 study conducted by researchers at the University of Missouri found that workers often retire when the market is cresting. Somewhat counterintuitively, that has the effect of reducing a portfolio's durability, unless the new retiree steers most of his assets out of the market and into an annuity.

Of course, bumps in the road are inevitable in any investing horizon of 25 or 30 years: Indeed, the past 19 years have been pockmarked by two major bear markets. But for new retirees, those downturns can prove especially painful and even lethal. The reason is what retirement researchers call "sequencing risk" or "sequence of return risk." That means that encountering big losses early in retirement while simultaneously spending from a portfolio reduces the amount of assets that are in place for the market's eventual recovery. Retirees who encounter a weak market environment later in their retirement years--say, when they're in their late 70s or 80s--are much less at risk for this problem than are early retirees. They've made it through the danger zone of their early retirement years, and their now shorter life expectancies mean their portfolios don't have to last as long.

In some respects, the market environment that you encounter over your own specific retirement horizon is what it is; you don't have any power to control when stocks drop, bond yields shoot up, or spending-power-eroding inflation materializes. But there are a few tactics you can avail yourself of to ensure that if the market gets off to a nasty start during your retirement years, you won't deal your portfolio a death blow. Here are some of the key ones to consider.

1. Delay the date but not the gratification.

If you're eyeing retirement but concerned about eliminating your paycheck in a lofty market that could experience a downturn, one idea would be to start with a work/retirement hybrid. Morningstar contributor Mark Miller has written extensively about "encore careers"--work that's potentially less remunerative than one's main career but more meaningful and more enjoyable prior to retiring for good. Alternatively, T. Rowe Price has conducted research on a "pre-tirement" strategy, whereby workers continue in their jobs but spend additional retirement contributions on travel and leisure pursuits rather than saving them. Those late-in-life retirement-plan contributions are less meaningful, from the standpoint of compounding, than those made early on. Meanwhile, the benefits of continuing to work—delayed portfolio withdrawals, delayed Social Security filing, not retiring into an at-risk market—greatly improve a portfolio's long-term durability. Of course, you can't always decide the date that you retire, and if you're in a job that you hate, it's wise to look for an escape hatch if it's financially viable. But if you like what you do—or can find your way to a paying position that you enjoy—that can help reduce the risk that stock market losses and falling bond prices pose for new retirees today.

2. Seek portfolio balance.

To help circumvent sequencing risk, researchers Michael Kitces and Wade Pfau asserted that retirees' allocations to stocks should actually start out more conservative and rise over time. Once retirees are safely through the danger zone of losing a lot of money in the early retirement years, they can then increase equity exposure in the portfolio.

That finding was somewhat controversial, but new retirees can partly apply that same concept by setting aside a healthy contingent of their portfolios in safer securities like cash and high-quality short- and intermediate-term bonds. If they do encounter a weak market environment right out of the box in retirement, they can spend from the stable assets while leaving the more volatile assets in place to recover. That's the general thinking behind managing your portfolio in buckets; even in a catastrophic market environment in which stocks fall and take 10 years to recover, retirees wouldn't have to touch the depreciated piece.

Similarly, our 2021 research on safe withdrawal rates pointed to balanced portfolios offering higher starting and lifetime withdrawals than portfolios that are more equity- or bond-heavy. Portfolios with between 40% and 70% in stocks supported the highest withdrawal rates over a 25- to 30-year time horizon.

3. Maintain discrete holdings to retain rebalancing opportunities.

One takeaway from my series of bucket portfolio stress tests was that at any given point in time—even during the depths of the financial crisis from 2007-09—almost something in my model portfolios was doing reasonably well. In 2000, it was value stocks; in 2008, government bonds gained ground. In my portfolio simulations, those appreciated positions provided an opportunity to prune the appreciated portion of the portfolio to use for spending, to refill the cash reserves, or to top up depreciated positions. Of course, you don't want to go overboard in terms of maintaining many small positions and there may be years (hello, 2022) when cash is the only position in the black. But at a minimum, having discrete U.S. stock, international stock, and bond components, along with a cash sleeve, can help ensure that a retiree never has to tap a position when it is down.

4. Adjust spending downward when encountering retirement turbulence.

The early retirement years are also the high spending years, on average, when retirees sate their pent-up demand for travel and leisure activities. But a "best practice" emerging from the growing body of research about tenable withdrawal rates is that retirees should, if they possibly can, rein in their spending amid market downturns. Market volatility in retirement can cause queasiness and a sense that things are out of your control; for retirees, reducing spending is a way to take back control amid the uncertainty. New retirees concerned about impending market volatility could simply start with a modest withdrawal rate. Alternatively, retirees could ratchet down their spending if they encounter a weak market and potentially spend more in an upward-trending one.

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About the Author

Christine Benz

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Christine Benz is director of personal finance and retirement planning for Morningstar, Inc. In that role, she focuses on retirement and portfolio planning for individual investors. She also co-hosts a podcast for Morningstar, The Long View, which features in-depth interviews with thought leaders in investing and personal finance.

Benz joined Morningstar in 1993. Before assuming her current role she served as a mutual fund analyst and headed up Morningstar’s team of fund researchers in the U.S. She also served as editor of Morningstar Mutual Funds and Morningstar FundInvestor.

She is a frequent public speaker and is widely quoted in the media, including The New York Times, The Wall Street Journal, Barron’s, CNBC, and PBS. In 2020, Barron’s named her to its inaugural list of the 100 most influential women in finance; she appeared on the 2021 list as well. In 2021, Barron’s named her as one of the 10 most influential women in wealth management.

She holds a bachelor’s degree in political science and Russian language from the University of Illinois at Urbana-Champaign.

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