Why 2022 was a dangerous time to retire – and what to do about it

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It’s a scary time for young retirees.

Shares have fallen this year. Bonds, which traditionally serve as a ballast when stocks fall, have also been hit. Both trends are worrying for seniors who rely on investing in their retirement income. High inflation also means that retirees need to raise more income to support themselves and make ends meet.

“This is a very bad combination that is relatively rare,” said David Blanchett, head of retirement research at PGIM, Prudential Financial’s investment management division, about this triple challenge.

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“2022 was a dangerous time to retire,” he added.

However, there are steps that retirees – and those who plan to retire soon – can take to protect their nest egg.

Because it matters

The S&P 500 index is down almost 17% in 2022. The index fell in the bear market sometime on Friday (meaning that the US stock index fell more than 20% from its recent high in January) before recovering slightly.

The Bloomberg US Aggregate bond index is also falling more than 9% this year. Bond prices are moving in the opposite direction of interest rates, a dynamic that has pushed bond capital as the Federal Reserve raises its benchmark interest rate.

Investors are more vulnerable to market shocks in the first months and years of retirement.

This is due to the risk of “yield sequence”. Someone who withdraws early retirement money from a declining portfolio is at greater risk of running out of nest egg sooner than a retired retiree years later.

When the market shrinks, it means that investors have to sell more than their investment to generate income. This depletes savings faster and leaves less room for growth when things recover, limiting a portfolio destined to last several decades.

The “sequence” – or time – of the return on investment is what matters.

Consider this example from Charles Schwab, two young retirees with $ 1 million in portfolios and $ 50,000 in annual withdrawals (adjusted for inflation). The only difference is when everyone experiences a 15% portfolio loss:

One has a 15% reduction in the first two years of retirement and a 6% profit every year thereafter. The other has an annual profit of 6% for the first nine years, a negative return of 15% in years 10 and 11 and an annual profit of 6% thereafter.

If you have been planning for 30 years [of retirement]these first few years can be very important in terms of what you will eventually experience for your result.

David Blanchett

head of pension research at PGIM

The first investor would run out of money after 18 years, while the other would have about $ 400,000.

“If you plan for 30 years [of retirement]”These first years could be very important in terms of what you will eventually experience for your outcome,” Blanchett said.

Of course, some retirees are more vulnerable than others.

For example, a retiree receiving all or most of Social Security income, pensions or income is not greatly affected by what happens in the stock market. The amount of these funds is guaranteed.

Also, the risk of yield sequence is probably less significant for someone retiring at an older age, because their portfolio will not have to last that long. Nor is it likely to greatly affect a retiree who has saved far more money than is needed to finance his or her lifestyle.

What to do

If new retirees are nervous, given the current market situation, there are some ways they can reduce the risk.

First, they can repay the expenses, thus reducing the withdrawals from their nest egg. A supporter of the “4% rule” strategy may choose to opt for an inflation adjustment, for example – although there are many different schools of thought about retirement spending.

Whatever the strategy, reducing withdrawals puts less pressure on the investment portfolio.

“Does that mean you can’t have a fun cruise or vacation? Not necessarily,” Blanchett said. “It requires us to think more about exchanges, possibly based on how things are going.”

Likewise, retirees can be restructured where their retirements come from. For example, to avoid withdrawing money from stocks or bonds (categories that are in the red this year), retirees can raise cash.

This goes back to the risk of sequencing and trying not to withdraw money from undervalued assets. Picking up a cash register while you wait for other assets to be recovered (hopefully) helps to achieve this goal.

“You do not want to sell stocks or bonds in this environment if you can afford not to,” said Christine Benz, chief financial officer at Morningstar.

However, retirees may not have several months or years in cash. In this case, they can draw on areas that have not been hit as hard as others – for example, perhaps on short- or medium-term bond funds, which are less sensitive to rising interest rates.

Employees who have not yet retired (and who are worried about having enough money to do so) may choose to work a little longer, as much as they can. Or, they may think of earning a post-retirement income to put less pressure on their nest egg.

Reducing the requirements on your investment portfolio is one of the most important things you can do, Benz said. For example, Social Security beneficiaries receive a guaranteed annual boost of 8% in their benefits each year they are late in claiming full retirement age. (This 8% boost stops after the age of 70, however.) Elderly people who can be late get a permanent increase in their guaranteed annual income.

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