Has Your Retirement Plan Been Stress Tested?

by Brian McGeough, CFP® Senior Relationship Manager

Approaching retirement is an exciting time for most people. Spending time thinking how you will live out your “golden years” is something that we all look forward to. 

You’ve worked hard for many years to accumulate and grow your wealth. Now is the time that you depend on that wealth to get through retirement, which could last 30 years or more! 

Ideally, you want your portfolio to start producing enough dividend and interest income to fill the gap between income from social security and any possible pensions you may have and what your expenses will be during retirement. 

There are many risks to your portfolio to think about as you get closer to retirement. Stock market volatility, interest rate fluctuations, and inflation. But one risk that people tend not to think about is “sequence of returns” risk, which could have a very big impact on your retirement funds. 

Over the last 30 years, the S&P 500 has had annualized returns of 9-10% on average. However, we all know that these returns don’t happen in a straight line and sometimes can be very volatile. Sequence of returns risk is the risk that the market declines in the early years of retirement, paired with ongoing withdrawals, and could significantly reduce the longevity of a portfolio. 

For example, consider two retired investors who invest $1,000,000 as retirement begins and plan to withdraw $45,000 per year. Over the course of retirement, their portfolios will generate similar returns but following a different pattern. The first investors start out with positive returns for the first 3 years before having a negative year. The second investor has a decline of 15% in the first year followed by gains in the next three years. After those first four years, both investors have the same pattern of returns throughout retirement. 

The chart below shows the impact of the different sequence of returns scenario:

At Chatham Wealth Management, we use some extremely bearish scenarios to see if your retirement plan holds up under different economic and market conditions. We create portfolios that are customized to what each client’s needs are. Having a diversified portfolio across asset classes, industry sectors and geographies and planning ahead for retirement is essential. 

Below are a few ideas of needs that a client may have and the type of strategy that we may use to help meet those needs: 

1) Liquidity – Pulling money out of investments at the early stages of retirement that have had a big drop in price to pay your bills has a long-term negative effect on your portfolio. It is good advice to have liquid assets available to meet liquidity needs for the first 3-5 years, such as cash, money market funds or short-term bonds. Obviously, there is much less volatility in these types of investments than in stocks. 

2) Income – We construct portfolios that have both stock dividend and interest income. We invest in companies that have strong balance sheets because they are in a better position to make it through tough times in the economy and the financial markets. Even if the market falls, the portfolio will still generate income. It’s advisable for this bucket to be made up of both stocks and bonds. While bonds are less volatile and have a maturity date for when you will get your principle back, it’s not likely that they will keep up with inflation. Also, there is interest rate risk, which means that interest rates could be much lower when your bonds mature resulting in lower income when you re-invest in the next set of bonds. Higher dividend stocks are often much less volatile than growth stocks with no dividend. These stocks will provide dividend income and potential appreciation over time. 

3) Legacy – This bucket may be for future generations or charities and can be considered for longer term investments with higher potential returns. We use a combination of traditional and alternative investments for these types of buckets. 

If you have any questions or would like a complimentary portfolio review and assessment, please contact Chatham Wealth Management at (800) 472-8086. 

Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.