Let Me Clarify
If you’ve been told “the market always comes back,” then you’ve been lied to. At least, a little bit. The U.S. market absolutely has recovered from past recessions, but that blanket statement assumes that we know future pullbacks will always perform the same way and does not reflect the importance of how long each recovery has taken.
Let me clarify.
I know I say it a lot, but we always need to remember that the only information we have is from the past or the present; we’ll never be able to accurately predict the future. And this is one of the biggest issues with the statement that “the market always comes back.” Japan is a perfect example of this.
I think we can all agree that Japan, as a country, is very different from the U.S. I think we can also agree that Japan is still a world leader in business and technology. Are you familiar with the Nikkei 225 Index? For those of you that may not be, it represents the Tokyo Stock Exchange.
Did you know that it fell from its peak in October of 1989 and has never fully recovered? That was 31 years ago! Sure, it still may recover at some point, but we have no idea when that might be.
Could that happen to the U.S. market? One of the most remembered points in history is the Great Depression of 1929. Obviously, there were wars and other events sprinkled into the Depression, but it took the market 25 years to return to the same level.
Next time you’re browsing around the history of the stock market, you should also look at what happened from 1968 to 1982, 1987 to 1991, and 2000 to 2013. All different points in history with different events taking place (and highs and lows in between), but they show market rebounds don’t always roar like we’ve come to expect.
“But, if the market comes back next time, why does risk matter?”
Let’s put ourselves in a retiree’s shoes.
Scenario 1: Retiree needs $40,000/year to live on in retirement. If he or she has $1,000,000 saved, the market drops 50% prior to retirement (similar to what happened in 2007-2009), and they are fully invested in the market, they are left with $500,000. After taking out the $40,000 needed to live on, the remaining account balance is now $460,000. This leaves 46% of the initial savings to fund the remaining years of retirement.
Scenario 2: Retiree needs the same $40,000/year to live on in retirement. If he or she has $1,000,000 saved, the market drops 50% prior to retirement, and they experience a 20% loss (due to a conservative approach and not being fully invested in the market), they are left with $800,000. After taking out the $40,000 needed to live on, the remaining account balance is now $760,000. This leaves 76% of the initial savings to fund the remaining years of retirement.
While I’m sure you could survive a 50% loss if you have $20 million saved, this goes to show the bigger impact on the average retiree. Again, the market could rebound in both scenarios, but who knows how long that may take or if it’ll even happen before running out of money. In this hypothetical illustration, it’ll take a lot more work, discipline, and sacrifice to stretch out 46% of what you started with.
The truth is most investors need to reduce their risk as they approach retirement. When you’re younger, and ample time is on your side, the downside is less likely to derail your future. But, when you’re in the retirement phase of your life, and your “paycheck” now comes from your own savings, large declines become a bigger hurdle than giving up some upside potential. Significant drops mean each distribution you take becomes a larger percentage of your portfolio and, in worst cases, you may run out of money a lot sooner than expected; just ask those who retired in 2009 and were soon looking to go back to work.
To use a baseball metaphor, think about the potential winning runner on third, with two outs, in the bottom of the 9th inning. They don’t need a home run to score. Sometimes all you need are bunts or singles to get you there.
As we embark on this clarifying journey together, I encourage you to submit any ideas, topics, or questions to firstname.lastname@example.org. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. “Let Me Clarify” is a weekly blog containing Chad Baxter’s insights and thoughts about a variety of topics. To learn more about Chad, click here
All performance referenced is historical and no guarantee of future results. All investing involves risk including loss of principal. No strategy assures success or protects against loss. This information is not intended to be a substitute for individualized legal advice. Please consult your legal advisor regarding your specific situation. Clarify Wealth Management and LPL Financial do not provide legal advice or services. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.