Give Me 20 Minutes and I’ll Dispel One of Retirement’s Biggest Fears

[00:00:00]If you are close to retirement or already in it, there are probably a number of big money fears that tend to gnaw at you. And one of the ones that seems to top the list for retirees is this question. What happens if the market crashes right after I retire?

[00:00:16]That fear has a name, sequence of returns risk. It's this idea that when the market falls also matters just as much as how much the market falls. Let's say the market falls 30% and you're seven years out from retirement. That's kind of difficult, but you can probably deal with it. Let's say instead the the market falls 30% and you're 2 years into retirement and you're in a situation where you need to keep taking draws from your portfolio. Well, if the market falls enough and you are forced to keep drawing from your portfolio, this could put your portfolio in a dangerous position. This could put you at the risk for running out of money down the road.

[00:00:56]On the other hand, if you retire into a really strong market and let's say you don't run into a large market downturn until you're say 20 years into retirement and that's when you experience a 30% market decline. Well, at that point it's probably not going to affect your retirement much at all. So, timing matters. Extreme losses early on can be painful depending on your circumstance. Hey guys, what's up? I'm Aaron and welcome back to the channel.

[00:01:21]Once you start selling shares in a falling market to cover living expenses, you're locking in those losses, you are reducing the number of shares available to participate in the eventual recovery.

[00:01:34]And if the decline is deep enough and long enough, it may damage your portfolio in a way that you may never fully be able to recover from. So that's a legitimate concern and we're not going to dismiss it. But today, we're going to use the data and show you that why for most retirees, assuming you go into retirement prepared, this risk is far more manageable than it may first appear. Let's start with the raw historical data. Here is every major US stock market bare market going back to 1929 along with two important numbers.

[00:02:09]Peakto peak recovery, how long it took from the prior market high to reach a new market high. And bottom to recovery, how long it took from the market bottom to recover back to the prior peak. Both columns matter, so only showing one of them would give an incomplete picture.

[00:02:27]Take a moment with these numbers. Some recoveries look fast. The 1980s crash, the brief 2020 COVID drop, the 1966 decline. Markets bounced back in months.

[00:02:40]Others were genuinely brutal. The.com crash and the 2008 financial crisis took years to fully recover from peak to peak. And then there's 1929, the Great Depression. Over 25 years from peak to new high. That is not a number we can gloss over. It's real. It happened. And it serves as a reminder that catastrophic events are possible. Yes, some full recoveries took many years, but once markets finally bottomed, recovery often happened faster than retirees emotionally expected. And here's where I want to give a quick nod to having cash reserves and a diversified portfolio. Because it's in these moments, in these tough market conditions, that you'll realize that having these cash reserves and a diversified portfolio gives you breathing room to allow for the recovery. But we'll get back to that.

[00:03:32]When we look at this table, it tells us something that's very important because a lot of people who look at this table of stock market bare markets think it tells the story of a typical retirement portfolio, but it doesn't. Not even close. Here's the part that people don't talk about enough. When we're looking at this data, retirees are almost never 100% invested in stocks. If you're going into retirement or you're already there, you're likely holding a portfolio that has stocks and bonds and cash and you likely have other income sources. And this level of diversification doesn't completely eliminate risk, but it does help you manage it better. And it turns the math in your favor more often. Let's look at a reasonable retirey portfolio.

[00:04:19]Let's say we have 60% stocks and 30% bonds and 10% cash or cashlike equivalents. And let's see how those same bare markets played out for a hypothetical retiree with this type of portfolio. That table certainly reads differently than the first. The losses are smaller and the recovery times are shorter. Most of the events that felt catastrophic when they originally happened look much more survivable through the lens of a diversified portfolio. The 2008 financial crisis dropped this portfolio roughly 16%. Not 57%.

[00:05:00]The dotcom crash about a 13% drop not 49%.

[00:05:05]the brutal 197374 bare market roughly 20% for this portfolio versus 48% for pure equities.

[00:05:16]And look at the recovery times here.

[00:05:18]We're looking at 3 or 6 months or maybe even a year, 2, or potentially even 3 years. Whereas in our previous table, it wasn't uncommon to see these recoveries take five, six or seven years in total.

[00:05:32]So this fundamentally changes the experience of retirement. Having a diversified portfolio makes a difference. Now there is one important caveat. You will notice 2022 on that list. That year was unusual because stocks and bonds both fell at the same time. Something that historically has been more rare. Here diversification didn't work as cleanly as it usually does. And it's worth acknowledging that balanced portfolios do not always work perfectly. But across history, we have seen that they have tended to reduce the impact of downturns. Let's bring this to life with an example. Imagine two retirees entering 2008. Both have a million-doll portfolio. Both retired just before the onset of the financial crisis, but their experience ends up being quite different. The first retiree is 100% invested in stocks as this information is often presented even though it's an unlikely portfolio for a retiree. They're fully dependent on portfolio withdrawals and they have very little cash set aside. During the financial crisis, the stock market ultimately fell nearly 57%.

[00:06:44]That retiree watched their $1 million portfolio temporarily collapse to roughly $430,000.

[00:06:53]And historically, it took the market roughly 5.5 years to fully recover back to its prior peak and about four years from the market bottom itself. Every withdrawal during that period likely felt terrifying, having to sell shares while the market was collapsing just to pay bills in retirement. The second retiree also experiences losses, but they entered retirement differently.

[00:07:18]They hold a diversified portfolio, 60% stocks, 30% bonds, 10% cash equivalents.

[00:07:26]During that same crisis, instead of falling nearly 57%, their portfolio may have declined closer to roughly 16%. Their $1 million portfolio temporarily falls to around $840,000 instead of $430,000.

[00:07:45]Historically, a portfolio like that likely recovered in closer to roughly 2 to 3 years from peak to recovery and perhaps 1 and a half to two years from market bottom itself. They also have meaningful cash reserves. They have social security coming in to help cover their baseline expenses. They have flexibility built in so they can lessen their draw from their portfolio should they fall on hard times. and that proves invaluable. Of course, neither retiree enjoys the bare market, but one feels emotionally trapped as they're forced to continue drawing from their portfolio as it's taking a severe beating. The other feels like they have more options. They experience a lesser decline and they have flexibility with their spending and this can give them a greater sense of peace. Here is a simple but powerful piece of math that explains why reducing your portfolio loss is so important. If the S&P fell 50% and you were 100% invested in stocks, you would need a 100% gain just to get back to where you started. That could take years. But if your diversified portfolio only fell 10% during that same event, which is exactly what the data above suggests is possible, you only need an 11% recovery.

[00:09:07]That might happen within months. What should matter most to you is not how the stock market's performing, but rather how your portfolio is performing. And those can be two very different numbers.

[00:09:19]This is exactly why obsessing with the S&P 500's daily movements can really mess with retirees psychologically because it's very unlikely once you're in retirement that the index is your entire portfolio. It's likely that you have a more diversified portfolio. It's likely you have some S&P 500 exposure, maybe some other equities, maybe you have bonds, maybe you have cash, maybe you have social security coming in and this changes your personal picture. If the market does take a serious fall early in your retirement, what are your actual options? Well, there are four and understanding all of them can change how you think about the problem. Option number one, continue withdrawing proportionately. This is the classic total returns approach. You simply keep drawing from the portfolio in the exact proportions regardless of what the market is doing. This is mathematically efficient and it maintains your allocation discipline, but it can be psychologically brutal because you're selling shares when they're taking a beating. And truth be told, most retirees do not follow this option because this is not inhuman nature to behave like a robot. When you see that your portfolio is taking a beating, it's kind of natural that most people will tighten their belt and they'll restrict or pull back on their spending a little bit. When they see that their portfolio is doing exceedingly well, they tend to give themselves permission to spend and enjoy a little bit more. This is human nature. Option number two, spend from a dedicated cash reserve. If you've set aside, say 1 to two years of dedicated living expenses in perhaps a high yield savings account, you can draw from this when the portion of your portfolio that's invested in the market is taking a beating. This can give you breathing room. Now, it doesn't eliminate the problem because a prolonged decline could have you totally exhausting your cash reserves, but it does help because it can reduce the number of shares that you have to sell at depressed prices.

[00:11:15]And that distinction matters more than most people realize. Here's the insight.

[00:11:20]The markets often recover before a retiree fully exhaust that cash reserve.

[00:11:26]So, this is the real argument for having one. It's not that you never touch your equities, but it helps reduce the number of shares that you have to sell at depressed prices or in those worst possible moments. And when you look back at that recovery data that we just walked through, this point really comes to life. For retirees who go into retirement with a diversified portfolio, most will experience recoveries in the ballpark of say 6 months, a year, maybe two when we're looking at historical data. Which means that a well-funded cash reserve, one to two years of living expenses, has historically been enough breathing room to get through the storm without making permanently damaging decisions. The markets recovered, the portfolios healed, and for those retirees who avoided panic selling during this time, they were in a prime position to take advantage of the recovery when it happened. And speaking of creating breathing room in retirement, one of the areas where expenses can really catch retirees offguard is health care, especially Medicare decisions. And that's why I've partnered with Chapter. A lot of people assume that Medicare is simple, but trying to make decisions around supplemental coverage and drug coverage and advantage plans and metagap plans and looking at networks and deciding when you should enroll can be a complicated process and the decision you make today will not only impact your health care, it will also impact your finances for the remainder of your retirement. Chapter is a Medicare advisory platform that helps people compare plans from a wide range of national and local carriers so that you can better understand what options may fit your doctors, prescriptions, and your financial situation. What I really appreciate is that their licensed adviserss can walk you through this process on a one-on-one basis, and they can help prevent you from making costly mistakes, especially since this is probably your first time approaching your own retirement. So, if you're approaching Medicare eligibility age or perhaps you're already on Medicare and you want someone to review your plan and give you a second opinion, it can be worth giving Chapter a call. I have a phone number and an affiliate link down below. Their advisers are wonderful and a great resource. If you use the affiliate link down below, just know I may receive compensation. Now, past patterns are not a guarantee, but history at least gives us a reason to believe this approach is grounded in something real, not just a feel-good strategy. It's worth saying that a cash bucket is not designed to eliminate the impact of a bare market, but it is designed to make it so that a retiree does not become reactive emotionally in the middle of a bare market. Option number three, temporarily reduce spending. This option is massively underappreciated and many retirees naturally do this in the midst of a downturn. Maybe they skip travel. Maybe they skip the upgrades around the home.

[00:14:19]Maybe these just pull back their spending a little bit. They gift a little bit less to family and friends.

[00:14:25]Even modest spending flexibility can dramatically improve a portfolio sustainability over time. Let's say you're willing to adjust your spending from your portfolio by 10 to 15%. This can dramatically move the math in your favor. So, your portfolio lasts over time. And keep in mind, when you're adjusting your draws from your portfolio, it's likely you still have other income streams. Maybe you still have social security, maybe you have a pension, or maybe you have income from a work. Option number four, lean on guaranteed income sources. This is where social security, pensions, annuities, and part-time income become psychologically and mathematically powerful. A retiree who's able to cover the vast majority of their necessary expenses from more reliable income streams simply is just not as dependent on their portfolio. They have the ability to dial back their withdrawals if their portfolio needs that. This gives them greater flexibility. If there is one thing to take away from everything we've just covered, it's this. A cash bucket is a tool and it's a useful one, but it's not the hero of the story. The retiree who handles the bare market best is not necessarily the one who has exactly three years in cash reserves. It's the one who's built flexibility into their plan from multiple different directions. The retirees who do best tend to have multiple income sources, not just their portfolio. Flexible spending, the ability to pull back temporarily without panic. Emotional discipline, the willingness to stay the course. some cash reserves to reduce forced selling at the worst possible moments and a diversified portfolio. So the losses themselves are smaller. That combination is far more powerful than any single tactic. If we experienced another 1973 to 1974 situation, perhaps another dot crash or a prolonged Japan style scenario, a cash bucket alone would likely not be enough. But a retiree having social security coming in covering a strong portion of their baseline expenses. A retiree with a diversified portfolio across bonds and equities. A retiree with robust cash reserves. Maybe that's a year or two or three. This retiree is in a strong position. They may not be invincible, but they're in a much stronger position.

[00:16:49]Bare markets are real. Sequence of returns risk, it's real, too. We're not here to pretend otherwise. But the narrative that a stock market crash will inevitably devastate a retireese's portfolio is usually built on the flawed assumption that a retiree is sitting 100% in equities, that they don't have any other income sources, that they don't have cash reserves, or they don't have flexibility with their spending.

[00:17:11]So, it's not usually the case. Most retirees are not that person. When you hold a diversified portfolio, when you have income from social security or other sources, when you have some cash set aside to create breathing room, and when you're willing to make modest adjustments during rough stretches, you are not experiencing the same bare market that the headlines are screaming about. you generally experience a milder version of it with smaller losses and shorter recovery times. And that matters. Retirees do not experience bare markets the same way the S&P 500 does if you're not 100% invested in the S&P 500.

[00:17:52]And understanding that matters. It matters that you understand your own personal situation in your portfolio. So protect your houses. Build diversification. Build in flexibility.

[00:18:04]build in other income sources and yes, keep cash reserves at the ready because when the market eventually pulls back, and yes, it will eventually pull back because that's what the market tends to do, you want to put yourself in a position where you're not forced to make a catastrophic decision because of that.

[00:18:21]So, what are your thoughts on portfolio diversification and how that can mitigate your losses? I'd love to hear.

[00:18:27]Leave a comment down below. I post new videos every single week. If you got anything at all out of this one, please give it a like. If you're new here, please consider subscribing. Or if you know someone who might get something out of this type of content, please consider sharing. I'll see you soon. Bye. Gives you diversification.

[00:18:44]Risk it can be. That was awful. 30% and you're 5 years out from retirement.

[00:18:54]They're doing construction and they shouldn't be. I hope your engine breaks.

[00:19:00]Like I [laughter] but a cross histo balanced daily movements can ex coming in to cover I that's weird social security cover what the freak coming coming in and this can in oh freaking a of course neither retiree enjoys the I'm >> [laughter]