As I mentioned in my retirement blog, many retirees with money in the “market” face a dilemma: outliving their money UNLESS the market recovers. They now know as “myths” what heretofore were known as “facts”. Facts such as: diversification works; blue chips stocks are safe; dividends can be counted on; retirement accounts are secure; market risks are suitable. Among these “myths” is: you’ll do fine in the market long-term. Ever noticed that “long-term” is never quantified? Let’s look at the long-term from the prospective of retirees or those in the retirement red zone.
Let’s say you and your spouse have saved all your working years, and at age of 63 (in late 2007) your retirement accounts totaled $450,000. Given your expected Social Security of $2,000 at age 66 (when you plan to retire) and your spouse’s $1,000 (50% of yours as a dependent), your retirement “nest egg” was adequate. In fact, by taking equal annual payments over 30 years, assuming a 5% earnings rate, you could count on about $30,000 yearly from your retirement money. You’ll have about $65,000 a year, with your SS benefits adjusted annually for inflation. With the house paid for, the kids educated and self-sufficient and your modest lifestyle, you’re feeling secure as long as your health holds up. Then along came the Great Recession and the market meltdown. Back to the drawing board!
It is now March 2009 and you’re one year away from the planned retirement. The $450,000 has shrunk to $225,000 and you’re afraid the carnage is not over. You’ve lost 50% of your nest egg. How much of your “long-term” will it take to dig out of this financial hole? Your first surprise was that a 50% loss means you’ll need 100% growth to get back to where you started. Your most recent calculation was a shocker: if $30,000 a year is withdrawn from your current retirement savings and the rest grows by 5% annually, there is nothing left in less than 10 years. Is that “long-term”? Plan-B is to withdraw $20,000 annually: your $225,000 is now gone in less than 17 years, still short of the “long term”. Also, prices (inflation) will surely be a factor over the next ten to fifteen years, so your “long term” could be even shorter. You decide to work another year in hopes things get better.
If you can save $25,000 during the extra year of working you’ll be helped because (a) you’ll have money for one more year of retirement and (b) you’ll have one less year of retirement: you’re two years closer to your goal but is that good enough? For your nest egg to recover fully, you’ll still need 80% growth to cover the 50% loss. At 7% compounded annually, which is not unreasonable, it will take almost nine years to reach $450,000. In the meantime just a 3% annual rate of inflation means a dollar today is worth $0.74 ten year from now – but one of your needs in retirement, medical services, has been growing at 8% annually. Another blind alley!
Now you know why “you’ll do fine in the long-term” is a myth for most retirees. You simply do not have the time to recover from a major market meltdown like that suffered since late 2007. No one knows the future direction or recovery time of the market. It may be logical to assume that given the precipitous drop in the market over the past 18 months, it will recover soon. But, in 1929 the market nosedived until 1932 and was then mostly anemic before diving again in the last 30’s. The wartime economy of the 1940’s put recovery on hold. The market did not again reach the October 1929 level until November 1954. Could it happen again? Anything is possible, but we sure hope recovery is soon and the 50% loss is erased quickly – but that’s not likely. So, when you next hear that “long term” the market is always the place to be, ask yourself: how long is the long term?
Shelby J. Smith, Ph.D.
March 2009
TheRetirementPros.com
Like many who have seen their IRA down (<40%) – I am 55 and within 10 years of retirement. I am ready to move a portion of my remaining IRA (that is equity dominant)into a Guaranteed Minimum Life Income Rider with spousal continuance – for a future income stream. Would greatly appreciate opinion on this strategy.
I think the Guaranteed Lifetime Income Rider is a great way to “lock in” a minimum income or to combine with Social Security benefits to make sure you don’t outlive you money BUT you have to be careful about the underlying product. For example, you’ve got to make sure you’ve got some latitude in case your circumstances change or you need the money lump sum. If you put your money in a Variable Annuity, you’ll get the GLI rider but if you change your mind you’re exposed to the market…so make sure you can live with the worse case outcome (and people now know that is 50% loss or more).
On the other hand, if you choose a fixed annuity with the Guaranteed Lifetime Income Rider you will avoid market losses and retain options if your circumstances change. Hope this helps. By the way, you can get the Guaranteed Lifetime Income feature only on insurance products.