Depending on who you listen to, economies around the world could be set for a recovery or on the cusp of recession. With that in mind, it might be time for people to review their portfolios and load up on fixed income.
“Over the past decade, the S&P 500 has returned more than 13% on an annualized basis,” wrote former Morningstar analyst John Coumarianos in The Wall Street Journal. That bull market run has left many portfolios plump and, if past studies are anything to go by, near-retirees might be convinced to quit the workforce while they’re ahead.
But as Coumarianos noted, people who retire at bull-market peaks are more likely to outlive their money. They may be convinced that big returns will persist — only to be let down as bear markets take their turn. To protect themselves, he said, investors approaching retirement should review how their money is allocated.
“To assist in that effort, we ran a simulation showing how various portfolio allocations performed for someone who had retired in 2000, the beginning of a bear market, followed by another later in the decade,” he wrote.
The researchers deliberately chose a retirement period beginning with bad years as a counter to investor optimism inspired by recency bias in the wake of a bull market. To simulate withdrawals, they applied a variation of the 4% rule: an initial withdrawal of 4% from the retirement account in the first year, followed by a 3% increase in the dollar amount withdrawn for each subsequent year to account for inflation.
Under the pure-stock scenario, a theoretical investor starting with US$500,000 fully invested in the S&P 500 would have had their nest egg eroded to less than US$200,000 at the end of 2018. That’s in spite of the index’s 4.86% annualized return over the 18-year period, including 13% returns from 2009 through 2018.
“Bad early years in a withdrawal phase can crush a portfolio,” Coumarianos said, pointing to two declines of roughly 50% (2000-2002 and 2008-early 2009) within the first decade of the simulation period. Nest eggs that suffered a double-whammy of withdrawals and losses were not left with enough time or money to fully recover, even with a roaring market later on.
“But increasing bond exposure, represented by the Bloomberg Barclays U.S. Aggregate index, helped the portfolio to hold up,” he wrote. By putting US$500,000 in a balanced allocation of 60% stocks and 40% bonds, retirees would have wound up with some US$424,000 in 2018 with the 4% withdrawal rule. A conservative portfolio, with 30% stocks and 70% bonds, would have held around US$508,000 at the end of 2018.
“Bonds’ annualized returns for the whole period of the study were on par with those of stocks—4.84% for bonds vs. 4.86% for stocks—but bond returns held steady in the market downturns,” Coumarianos said. The cumulative returns for bonds in 2000-2002 clocked in at 33.5%, then 5.2% in 2008-2009.
“All of this means investors on the verge of retirement should contemplate having no more than 60% stock exposure and might prefer less,” he said.
Follow WP on Facebook, LinkedIn and Twitter