Secret to Retiring on a Bear Market

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Posted under Content Other on Tuesday, 24 November 2009 by admin

Here’s a formula for a comfortable retirement: Wait for stocks to plunge 30%. Watch your neighbors panic and market pundits suffer palpitations live on camera. Then quit your job.

Sound scary? That’s the idea.

As stocks continue to distance themselves from their March 2009 lows, many folks approaching retirement are no doubt breathing easier. With their stocks and stock funds up possibly 60% or more, they are likely feeling better about their financial future and may be more comfortable giving up their paycheck.

But a high-flying market creates a false sense of security, as those who retired at 2007’s stock-market peak can attest. Indeed, a bear market is a better time to retire because it offers a much-needed reality check. If you have enough to retire when stock prices are depressed, maybe you really are financially ready.

Riding the Bear

To be sure, retiring amid plunging stock prices has its downside. Among academics and financial advisors, there has been much fretting over what’s sometimes called “sequence-of-return risk.”

The notion? Bear markets may be good for savers, because they can buy shares at beaten-down prices. But such markets are rough on retirees looking to cash out.

One nightmare scenario that some recent retirees are now struggling with: Your nest egg is eviscerated by the double whammy of slumping stock prices and your own need for spending money. You find yourself possibly pinching pennies for the rest of your retirement.

But there are ways for retirees to ride out bear markets without selling stocks at fire-sale prices. For instance, you might keep a cash cushion equal to maybe five years’ spending money stashed in money-market funds and short-term bonds. Whenever stocks get whacked, you could draw on this reserve to pay the grocery bills, while you wait for share prices to recover.

Alternatively, you might figure out the minimum income you need in retirement. You would then aim to generate this income without selling investments, relying instead on a combination of dividends, interest, annuity income, pension income and Social Security benefits. During bear markets, you might limit yourself to this minimum income. Meanwhile, during bull markets, you could be a little freer with your spending, cashing in some of your stocks to pay for extravagances, such as a new car or a European vacation.

Calling It Quits

This sort of thinking highlights an important point: The total value of your nest egg is not as important as you think it is. What really counts is the level of income that your savings can support.

If you plan to generate a chunk of this income through dividends and interest, as many investors do, it doesn’t much matter that the Dow Jones Industrial Average has soared some 60% over the past eight months or that bond prices have been climbing. The dollar value of the dividends and interest you’re receiving likely hasn’t changed too drastically.

Today, with the stock market yielding less than 2½% and 10-year Treasury notes paying below 3½%, very few retirees could cover the bills solely with dividends and interest. Instead, seniors might need to create their own dividends—by occasionally unloading some of their investments.

True, you want to sell only when your stocks and bonds are up handsomely. But at the same time, you don’t want to retire with a false sense of security because the value of your portfolio has been puffed up by a rip-roaring bull market. After all, the next major move by the market may be a tumble—and you might discover your portfolio can’t generate the retirement income you’d been expecting.

That’s why bear markets aren’t such a bad time to retire: If stock prices are already off 20%, 30% or more, a lot of the exuberance has likely been squeezed out of the market and you can have a little more confidence that you aren’t looking at bubble prices.

Retiring in bad times doesn’t guarantee dazzling results in the years ahead. Still, everything else being equal, if the stock market has been knocked lower, future returns ought to be higher—and thus every $1 saved should be able to support a higher level of retirement income.

In a sense, a bear market creates a financial cushion. If you can look at your beaten-up portfolio and remain confident that you have enough to retire, maybe you are indeed in good enough financial shape.

Of course, you might get a little impatient waiting for the next bear market to arrive. Want to retire today? Before you tell the boss, take your stock portfolio’s value and mentally lop off 30%. Still feel you have enough money socked away? That’s probably a good sign.
Source Wall Street Journal