As Warren Buffett says when the market starts to struggle, it’s “good news” for his investing strategy. That’s because he’s constantly on the look out for more shares, seeking opportunities that the short-term market may leave cheap.
He feels that way because as the market drops, like the one we’ve experienced over the past couple weeks as the world responds to COVID-19 or the novel coronavirus, it supplies him with a sale on shares. And we’re seeing prices drop in a way that we haven’t experienced in over a decade as nations try to contain the spread of the virus. The S&P 500 index has fallen 19% since mid-February and on Monday the Dow Jones Industrial Average sunk an additional 2,013.7 points, or 7.8%, the largest one-day decline since October 2008.
Yet, for savers, all this volatility and fear means that stocks have gone on sale. It’s just as true for those years away from retirement as it is for Buffett, since over many years, you expect the market to rise. But there’s one group that this sell-off impacts more than any other: Those recently retired.
“The implications on retirement plans over the coming months is troubling,” said Han Yik, head of institutional investors at the World Economic Forum. “It is reminiscent of what happened at the end of 2008, early 2009, when equity markets last crashed."
A dip as you step away from regular pay is the worst case scenario, whether you’ve retired at a more traditional age or taken the leap in your 30s or 40s, such as those that follow the financial independence, retire early (FIRE) movement. It’s hitting the negative arc in what’s referred to as sequence risk. This occurs when the portfolio falls right as you’re retiring and you begin to draw down the money, which locks in the losses you’re seeing on the television screen. Sequence risk has two fangs. First, you’re depleting your portfolio by cashing in losses, but you also have to sell more shares in order to cover your expenses. This second dagger limits how much your portfolio can grow once the market improves.
Take a saver that retired on January 1, 2000, for instance. T. Rowe Price found the retiree would have seen her $500,000 portfolio with a 60% stock to 40% bond mix drop to $365,000 by February 2003, while pulling out 4% for living costs. After rebounding, any gains would have been decimated by the financial crisis, as the portfolio would nearly drop below $300,000. Even with this more than decade-long bull-run, the portfolio stands at less than $405,000 by the end of 2018.
“This market has been scary,” said Jackie Cummings Koski, who retired at the age of 49 in December. “ I was knowledgeable enough about the stock market to know that we were way overdue for a correction, but didn’t expect it would be so dramatic.”
But for Koski, she’s feeling safe because she prepared in case of such a scenario. Whether the coronavirus lingers, leading to even deeper cuts in the market, or it serves as a short-term volatile blip, here’s how those that retired in the past couple of years, with potentially 40-year retirement time horizons (or more), have approached the concern.
Keep The Drop In Perspective
While the numbers on television or your phone’s screen seem dramatic, having drops such as these isn’t a rare occurrence. It’s only when the drops linger for extended periods of months (or even years) when they become problematic while you’re in saving mode.
“I expect the market to drop at least 10% at some point most years because it usually does,” says Leif Dahleen, a former anesthesiologist who retired late last year at the age of 43.
One tactic that retirees take, in order to prepare for such a scenario, is to have a number of years of expenses sitting in a high yield savings account or short term bonds, providing easily accessible cash if needed. Koski, for instance, set aside three years worth of living expenses, in case such a situation like we’re experiencing played out.
It allows you to avoid tapping the stock portfolio, as the market falls, which would lock in the losses that sequence risk brings.
Keep A Foot In The Work Door
Leif Kristjansen, a blogger who uses the name as his nom de plume at Five-Year FIRE Escape, retired in mid-2018 at age 32. While he has enough funds saved to completely step away from the day job, he decided to continue to work one day a week at his current office.
“It helps give me structure,” Kristjansen said. He went on to add that by working part-time, and “knowing I have a lifeline to pull gives me so much confidence right now. Almost, no market scenario can scare me.”
While Dahleen doesn’t have a part time job, he does keep his options open as well. “I have kept an active medical license and am current on continuing medical education,” he said. “It's good to have a contingency plan in case things go awry.”
The research supports the opinions.
If you need $40,000 a year to live, and you have a portfolio of $1,000,000, then with a 4% withdrawal rate, you have a 95% chance of your money lasting the rest of your life, assuming a thirty-year time horizon. But if you earn $20,000 a year after taxes in a part-time job, and only pull out 2% of your portfolio, then the chance you live longer than your money drops down to practically zero. That’s the case in situations where you have a 40-year retirement horizon as well.
It’s A Good Time To Buy
Koski, who blogs at Money Letters, has used the opportunity to increase some exposure to companies she has wanted to own within her single stock portfolio.
“I think times like this are a great chance to pick up shares of companies I’ve been wanting to buy or add to an existing position,” she said.
Since she’s not a strict index fund investor, like many others within the FIRE community, she’s honing in on specific companies. If the market continues the spiral downward, then she might consider moving some of her cash and bonds into stocks, since she doesn’t have another source of income to take advantage of the cheaper stock prices.
That’s the similar mindset Kristjansen will take with the current market. He keeps a portion of his portfolio in bond funds, serving as a cash reserve in case he needs it for some of his rental properties. The funds can “be pushed into stocks if markets really take a turn for the worst,” he said.
As for Dahleen, who blogs about his retirement strategies at Physician on Fire, he’s using the opportunity to cut down his tax bill by selling some funds that have lost money and then immediately buying a similar structured fund. It’s referred to as tax loss harvesting.
By locking in the capital losses, he can use it to reduce any capital gains he might have in the year. The market fall has been large enough to where he views it as a smart option, since the fund he sold had four figure declines. The caveat to this strategy is to immediately move the money into a very similar, low fee fund, or else you’ll miss the chance for your cash to rebound.
It’s just one of the ways these early retirees sit still in this volatile market, while looking for ways to strike, if they can.