Could Retiring During a Down Market be a Big Mistake?

August 26, 2020 Author: Tess Downing, MBA, CFP®, Complete View Financial

Complete View Financial

Is it time to retire? Those last few years of gainful employment are not supposed to look like this. Essential workers are being exposed to harmful contagions. Long-time office employees are forced to work from home. In some sectors, jobs have disappeared completely. Could retiring in a down market be a mistake?

Leaving the workforce is a financial decision that shouldn’t be made impulsively. Our primary goal as a financial planner is to make sure you are making the best decision given your resources and future goals. Leaving your job right now may not accomplish that.

In this article, we’ll review the dangers of “sequence risk” and go over standards for setting up a safe retirement disbursement plan. We’ve also included some market insights for the remaining months of 2020.

The Sequence Risk Effect on Retirement

During employment years, the average employee contributes a portion of their income to a 401(k) or pension fund. More affluent individuals also open a Roth IRA and build an investment portfolio. This is often described as the “wealth-building” stage of a person’s life.

Upon retirement, the trend is reversed. Rather than contributing, a retiree is withdrawing from investment accounts. If the values of retirement funds and stock portfolios are high, those withdrawals could conceivably be covered by market gains and dividends.

Those who retire when market values are low, or in “downtrend,” will start consuming principle earlier because market gains will be lower than disbursement amounts. That shortens the lifespan of any finances built up during the working years.

This phenomenon is known as “sequence risk.” The markets have been in a steady uptrend since 2009, so it has not been an area for concern for retirees. This year, with an unprecedented global pandemic, we’ve already experienced one “bear” market.

Stock Market Projections for 2020

It’s impossible to say when the next market downtrend will occur. You can be certain it’s coming, though. With a presidential election and unanswered questions about vaccines and new outbreaks of Covid-19, the market will assuredly experience high volatility this fall.

That’s not a doom and gloom prediction. The stock market has consistently shown a return of 10% or better for decades. Workers not planning to retire soon should still contribute the max to retirement funds and invest additional dollars whenever possible.

For potential retirees, working with your financial planner to ensure you have a withdrawal plan for retirement cash needs is essential. Obviously, you can still retire but you must be prepared and your retirement plan stress tested for various market return scenarios.

Protect Yourself with a Safe Withdrawal Plan

Sometimes retirement is the only option. For those in that position, the industry standard for “safe” withdrawals from your retirement fund is 4%. With a $1 million principle, that’s estimated to be $40,000 a year for twenty-five years or so, as a simple calculation.

In a down market, that $1 million principle could shrink. Obviously, this decreases your initial portfolio value making your future withdrawals less.

There are a number of part-time employment opportunities to supplement that smaller income. Take advantage of those gigs in early retirement to be more comfortable later on.

Maximum Contribution Advantage for Older Workers

The maximum annual contribution amount for employees who participate in a 401(k), 403(b), or a 457 plan is $19,500. After age 50, you’re eligible to do “catch-up” contributions of an additional $6,500 per year. Down markets are a great time to take advantage of that.

Buy low. Sell high. It’s been a standard rallying cry on Wall Street since the beginning of time. Market losses mean lower stock prices. By contributing additional money into your retirement fund during a down market, you are literally “buying low.”

The world is a very different place from when you first started working. Don’t let it get you down. A comfortable retirement is still possible with proper planning. Retiring in a down market or more volatile market is not impossible, it just requires additional knowledge and planning to ensure your retirement years are enjoyable and comfortable.