Seven tips to help mitigate the risks investors age 55 and older face with their retirement savings
Market volatility can have greater consequences for those in or near retirement. But there are strategies to help mitigate these risks.
Authors
The recovery that financial markets experienced in 2023 provided welcome relief for investors after the major downturn that came in 2022. Still, a bear market can have a lingering impact. Part of the reason for that is that the rebound after any decline has to occur at a higher magnitude than the drop to make up for the lost ground. A 20% downturn can’t be overcome simply with a 20% rebound the following year, for example. The math doesn’t make that possible. The 20% decline would reduce a $100,000 portfolio to $80,000. A 25% gain the following year would then be necessary to bring that portfolio back to its original $100,000 value.
Investors often attempt to shield themselves from the volatility of the stock market by investing in a balanced portfolio that combines stocks and bonds. But as the US Federal Reserve began hiking interest rates in 2022 to combat high inflation, the US bond market experienced its worst year on record.1 That shocked investors who relied solely on a mix of US stocks and bonds for diversification.
The bounce of 2023 after the decline of 2022 fell just short of bringing a 60/40 portfolio back to whole
Consider the experience of the past two years for investors who had their retirement savings in a traditional balanced portfolio of 60% stocks, 40% bonds.
Figure 1: The market’s impact on stocks and bonds in 2022 and 2023
2022 return | 2023 return | Cumulative | |
|---|---|---|---|
US large-cap stocks
| -18.11% | +26.28% | +3.4% |
US investment-grade bonds (represented by the Bloomberg US Aggregate Bond Index) | -7.63% | +1.86% | -5.9% |
Year-end value of a 60/40 portfolio
| $86,082 ($60,000 in stocks reduced to $49,134 and $40,000 in bonds reduced to $36,948) | $99,681 ($62,046 in stocks $37,365 in bonds) | -0.03% |
Key takeaway: After the 18% downturn in US large-cap stocks in 2022, it took a 26% return in 2023 to bring investors back to just short of whole by the end of those volatile two years.
Source: Schroders. This is a hypothetical portfolio provided for illustrative purposes only and is not intended to be an investment recommendation. US large-cap stocks are represented by the S&P 500 Stock Index. Bonds are represented by the Bloomberg US Aggregate Bond Index. It is not possible to invest in an index. Past performance offers no guarantee of future results.
Older investors are worried
The wild swings in the market over the past two years do have older investors concerned, as the Schroders US Retirement Survey 2023 revealed:
- 59% of investors aged 55-64 said their portfolio declined a lot in 2022.
- 82% worry about a major market downturn significantly reducing their assets.
- 31% of their retirement assets are in cash.
- Six in 10 are fearful of losing money, which may explain their high cash holdings.
Even with their need to keep their assets growing, investors age 55 and older are worried about exposing their retirements to a degree of losses from which they might not be able to recover.
Those in or near retirement face a distinct set of risks
Older investors face challenges their younger peers don’t. First and foremost, they have a shorter time horizon. Even if they live for 20 or even 30 more years, older investors don’t have the multiple-decades timespan that provides younger investors with plenty of time to make up for the ground their savings might lose during a severe market downturn. Even beyond that basic fact, four key retirement savings risks become heightened for older investors.
- The risk of losses, especially in the early years of retirement (also known as sequence of returns risk). Those early losses can hit hard, especially if retirees need to take out a set dollar amount monthly, rather than a percentage of their savings. The fixed withdrawals amid a major market decline can reduce their total savings to a degree that could be hard to overcome even when the market recovers.
The risk of inadequate allocation. The lesson 2022 taught, as both stocks and bonds declined, is that relying solely on the two traditional major asset classes may not provide sufficient diversification. Alternative asset classes, such as commodities, may also need to be part of the mix to provide true diversification.
The risk of costly emotional decisions. When markets seem to be in freefall, it’s a natural temptation to rush for the exits. But kneejerk reactions can lead to bad long-term decisions. Anyone who exited at the end of 2022 and stayed in cash throughout 2023 would have missed the opportunity to make up for lost ground.
Risk of losing control. Some investment alternatives, like annuities, offer retirees a strategy to avoid market volatility by converting their savings into a lifetime stream of fixed monthly payments. Once the conversion is done, it can’t be undone, however. As tempting as the predictable stream of income might be, once someone “annuitizes” any portion of their savings they don’t have any options to alter the strategy they’re using to access their savings.
Seven strategies to mitigate these risks
Older investors don’t need to throw up their arms in defeat after a severe market retraction. There are strategies that can be deployed to help mitigate the risks that come from volatile markets.
- Broaden your diversification. One way to mitigate the risks of a year like 2022, when both of the two major asset classes experienced significant drawdowns, is to diversify into other asset classes like international stocks and bonds or alternatives, such as commodities.
- Make sure your allocations match your risk profile. As you age, your needs and even your tolerance for risk may change. At least at the end of every year, check to make sure your allocations across the conservative to aggressive spectrum of investments matches your age, time horizon and current views about the risk you’re willing to undertake.
- Rebalance your holdings regularly. Rebalancing your portfolio does two potentially beneficial things. First, restoring your holdings across asset classes to your desired allocation at the end of every quarter or year ensures that market activity doesn’t put your portfolio out of alignment with your risk tolerance. Second, as you rebalance, selling some of your strong performers to put more into investments that might have had a short-term down period, you effectively implement that age-old truism for success with investing: “buy low, sell high.”
- Do a thorough assessment of all your sources of retirement income and plan accordingly. In addition to personal savings, most people rely on Social Security for retirement income. If you retire early, though, your benefits will be reduced. If you work past the age at which you could receive full benefits, though, Social Security will boost your benefit by about 8% for every year you wait, up to age 70. While retiring early is a common dream, doing work you enjoy for a few years longer could enable you to have a higher retirement income and make you less reliant on your personal savings
- Take percentage withdrawals rather than a set dollar amount. Taking out a set amount every year from your retirement savings could make your total savings decline faster, especially if the market is particularly turbulent in the early years of your retirement. Withdrawing a percentage amount annually can lessen that risk. Instead of taking out $50,000 annually to meet your living expenses, for example, consider taking 3%. For a hypothetical account with a $1-million balance that might mean withdrawing $24,000 in a year when the market was down 20%. But if the market were up 20%, you’d be able to take out $36,000. It requires some flexibility and the ability to draw on other sources of income to cover your monthly expenses, but the percentage withdrawal method could help lessen the impact of market downturns over the course of your retirement.
- Think twice before “annuitizing” all your savings. While a fixed monthly payment may seem appealing, you will have more flexibility if you keep control of all or a good portion of your retirement savings. Your retirement circumstances can change, after all. If you downsize to a less expensive home, for example, your monthly income needs might be less. If you receive an inheritance that is more than you expected, you may have an additional reliable source of income. Even though federal tax law requires you to start annual minimum distributions from your 401(k) plans and IRAs will once you hit your early seventies, keeping your savings in a vehicle that doesn’t convert your savings into an income stream could provide you with the flexibility you’ll need.
- Invest your most important assets in strategies that actively manage risk. One of the lessons to emerge from 2022 was that an unmanaged 60/40 allocation to stocks and bonds doesn’t work when both of the major asset classes get caught in a downdraft. A dynamic allocation that could have moved into other asset classes or even cash during the decline might have helped offset its impact. Target-date funds have a similar problem because their allocations are fixed, and the only adjustments made are based on how close someone is to their retirement date. After investors reach retirement age, these funds typically convert to – and remain at – a fixed allocation of 30% equities and 70% bonds and cash. These allocations can still leave retirees exposed to risk in down markets and also keep them too much on the sidelines when there are opportunities to realize gains in strong markets.
All investors – and those age 55 and older especially – need a solution that has the flexibility to mitigate risks and capture opportunities while letting them stay in the driver’s seat, making choices about how they access their savings.
Staying in the right position for rebounds
Investing is a bit like basketball in that the best way to catch rebounds is to be in the right position for them. That may mean staying invested with a product that seeks to both mitigate the risks and capture the opportunities the markets present. With the right solutions, retirees may be able to enjoy a comfortable retirement income that isn’t entirely dependent on the whims of the financial market
1Source: “2022 was the worst-ever year for U.S. bonds. How to position your portfolio for 2023,” CNBC.com, 1/7/23
All investments involve risk including the loss of principal.
Subscreva o nosso conteúdo
Visite o nosso centro de preferências e escolha que informação deseja receber por parte da Schroders.
Authors
Topics