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| It took about eight years to recover lost ground in the early-1970s bear market -- if it takes that long again, thats going to significantly change the amount people can expect to retire with. --Richard Wagener, financial planner | |||||||||||
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Recent articles by Karen Hube: • How to drop out and live off your nest egg, 6/11/2005 • New parents' top 10 money mistakes, 4/2/2005 More... |
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The bear market may be over, but it will take time and planning to rebuild your portfolio. Here are four steps you can take now to plan for retirement whatever happens next. By Karen Hube Pffffft! Thats the sound of the wind getting sucked out of a retirement plan. While almost all investors took losses in the three-year bear market, theres no question that those who suffered the most were people on the brink of retirement. And the market hasn't done much since to repair the damage. Its hard enough leaving the security of the working world when the market is in an upswing, says Malcolm Makin, an investment advisor in Westerley, R.I. But now its not just psychologically difficult -- for some its financially disastrous. Even people who still have 10 years to 15 years before they retire have reason to be concerned that those down years derailed their plans. It can take years to rebuild a battered portfolio. It took about eight years to recover lost ground in the early-1970s bear market -- if it takes that long again, thats going to significantly change the amount people can expect to retire with, says Richard Wagener, a financial planner in Columbia, Md. Retirement portfolios tend to have a healthy mix of stocks and bonds, which helps buoy returns in market downturns. But nothing could shield them entirely from the fallout of the bear market. So now, many are facing the possibility of having to completely alter their retirement plans. Were going to see some people who have to put off retiring for a while or at least continue to work part time to get through this rough period, says Lynn Ballou, an investment advisor and financial planner in Lafayette, Calif. Downturn really hurts Yes, perhaps the drought is over. But planners say a severe and prolonged market downturn in the early years of retirement can have a drastic affect on how long a nest egg will last -- even if your overall average annual return during retirement is high. Consider the period between 1968 and 1998. During that time, the average annual return on the S&P 500 was 11.7%. According to an example by T. Rowe Price, if an investor retired in 1968 and correctly assumed an 11.7% future average annual return, he or she could have figured it would be safe to withdraw 8.5% of assets in the first year and then increase withdrawals by 3% each year after that to adjust for an increase in the cost of living. In reality, though, the portfolio would have run out of money by 1981, because at the start of this period, especially in the mid-1970s, stocks performed poorly. The bulk of the gains would have come starting in 1982 when the bull market began. If, instead, the market had been generating the kinds of returns we saw in the 1990s, the portfolio would have ended up with far more in retirement reserves than needed. Ideally, of course, no matter how much you have socked away or what happens to the stock market, your retirement plan should be designed to make your nest egg last. But the reality is that even people who carefully planned and crunched the numbers probably didnt figure on such a severe drop in the market, Ballou says. So how do you figure out if youre still in good shape to retire -- or if you should stay on the payroll for another couple of years, or longer? First, go back to the drawing board Crunch the numbers in your retirement plan, but this time avoid overly simplistic retirement planning methods that assume a single average annual return. People should always take into account the ordering of returns, but now its particularly important, says Christopher Cordaro, a financial planner in Chatham, N.J. If you hire a financial planner to run the numbers for you, choose one who is using some of the newest software that allows him to run sophisticated analysis of your portfolio. A growing number of planners have in the past couple of years started using software that uses the so-called Monte Carlo method of analysis, which determines the probability that you will meet your goals based on a number of variables such as your age and withdrawal rate. If youve got another decade or so before retirement, draft a new retirement plan that extrapolates from your portfolios current value, Wagener says. Most people who have 10 or so years until they had planned on retiring will probably be able to stick to that schedule, assuming they save aggressively until then, he says. But theyll find themselves way off track unless they run the numbers to factor in the current market. Size up your cash savings and income prospects Ultimately, one of the most decisive factors that will determine how soon you can hang up your briefcase is how much cash and income from pensions and other sources you can count on. You really have to have enough to get you through a down cycle in the market, Makin says. The last thing you want to do is have to sell stocks to generate income when the market is down. One question is, then, is the market slump really over? On average, market dips recover after two and a half years, but the 1970s is an example of a much longer cycle, Wagener says. Many planners say its safe to assume youll need to be able to cover three or four years' worth of expenses using your cash reserves or income from, say, a pension or Social Security. For some, this could mean working for another year. But others, such as those who were planning to live primarily off of money stashed in stock investments, may find it will take several years to bulk up a safety net. That's because, as planners often point out, to rebuild an investment after a 50% loss takes a 100% gain. Several years may sound like a long time when you already have visions of relaxation, Ballou says, but this isnt something you want to skimp on. Renegotiate your departure If, after careful analysis, you find youre no longer in great shape to retire soon, your best bet is probably to continue to work for another year or so to weather the stormy market and sock away more cash, says Peg Downey, a financial planner in Silver Springs, Md. Meanwhile, if you have already given your company notice, check with your human resources department immediately to see if you can revise your retirement date. Whether or not your company will agree isnt a legal issue, its a matter of what you can negotiate, says Priscilla Claman, president of Career Strategies in Boston. A secondary alternative is to retire, but cut the income you had planned to withdraw. But no one wants to give up the retirement lifestyle theyve been planning on. Clearly youre better off staying employed, if you can, Downey says. One year or two of more work isnt such a great price to pay for some security and comfort in retirement. Bulletproof your portfolio Theres one last task before you should consider crossing the Great Divide to retirement: Make sure you never have to fret about your retirement portfolio again. The trick is to structure your portfolio so that you get a continual and reliable flow of income no matter what happens to the stock market. Ideally, many financial planners suggest holding no less than one years expenses in cash and three years' worth in a laddered fixed-income portfolio. This structure should be established within five years before retirement and maintained throughout retirement. This means youll want to hold a number of bonds, Treasurys and other fixed-income investments with different maturities, either individual issues or through bond funds. (Many planners recommend low-fee no-load bond funds because, even though you pay a fund fee, theyre usually cheaper than if you bought individual issues.) That way, you create a continual flow of income as investments mature. You wont have to worry about selling stocks at an inopportune time, Ballou says. During down markets, then, you can live off the income generated from your fixed income and sell some of your bonds, Treasurys or CDs if you have to raise more cash. In better times, you can sell shares of stock to generate cash and replenish your four years reserves in cash and fixed income. If youre about to retire and you dont have this structure in place, start establishing the structure slowly. Use cash you have on hand that you wont need for the next year to start building the laddered fixed-income portfolio. And if you have dividend-paying stocks or income from bonds that you dont need over your first year of retirement, funnel it into the fixed-income portfolio. | |||||||||||||||
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