How Does One Guide a Retirement Plan Through a Down Market?

The bears among us are now emerging from hibernation to discover the S&P 500 has turned green just as spring arrives. Should the rest of the year progress at the same rate, the result would be a modest 4% full-year return. That would be a disappointment in most years, but 2016 has not started like most, as those not napping through the winter can attest.

A steep slide from the outset left the S&P 500 11% lower by mid-February. From there, stocks spun around and quickly retraced their losses. Now is a good time to assess our retirement plans, the markets and how to navigate the worst of them. History tells us that bear markets are inevitable – the next one could be right around the corner or may still be years away. Will you be ready?

What just happened?
Think of a boat where the passengers are clustered on one side peering through the wind and the spray, transfixed by the menacing clouds seemingly headed their way. It’s a vortex of Fed interest rate increases, a shaky Chinese economy, and oil prices collapsing at an alarming rate. But the storm heads in another direction, and the passengers back away from the rail towards their seats. Their movement causes the vessel to roll in the other direction, a surprise to all. It’s awhile before the rocking settles down to the natural motion of the boat making its way through the water. Yet the storm is still out there – its intensity and course unknown.

What do bear markets look like?
The Down-and-Back: A bear is described as a drop in the overall stock market of 20% or more from a peak. There have been 20 such instances since 1928, an average of one every 4 ½ years. The average decline was approximately 37% and lasted about 12 months. Recovering to prior market highs has taken from less than a year (1938) to many years (1929, 2009).

A reasonable defense for a sharp selloff in stocks is liability matching – identifying and maintaining low-risk assets that can be counted on to fund living expenses for several years, without necessitating a shift away from stocks when the bear is most fierce.

The Long, Slow Grind: Although perhaps not as alarming in the moment, an extended period of subdued stock market returns is a greater risk to the long-term success of a retirement plan than the down-and-back bear. Over a period of five or more years, this scenario would be defined as returns that are less than inflation plus one or two per cent. From the middle of 1975 through the middle of 1980, the market suffered four corrections (>10% sell off) but no traditional bear markets and the average annual return adjusted for inflation was near nil.

To help protect against the extended bear, consider how you would meet your goals with stocks providing lower-than-expected returns for a prolonged period. Accounts balanced with bonds and dividend paying stocks can provide a base level of income.

How do I assess my situation?
Having a plan facilitates an objective, though far from perfect, analysis of these variables. Scenario analysis to stress test your portfolio is an important tool. Knowing how a bear market would impact your chances of success in retirement can highlight opportunities to make changes now while fear has subsided.

Once you have evaluated the effect of weak returns from stocks, consider “How would my plan be affected if I choose to decrease my allocation to stocks?” and “How do my chances of success differ between retiring now and working part-time for a few more years?”

There are factors under your control that will increase the probability of surviving a bear market in retirement. When challenging times arrive, have a plan to reduce or postpone spending as necessary. Devote as little time as possible focusing on factors that, while important, are beyond our control – market returns and volatility, government and tax policy. A good plan should help you anticipate where you can make adjustments, as well as where you can’t or shouldn’t respond.

Bear markets have significant consequences for retirement planning. While there is often little to no advance warning, we know they will come. For retirees who are spending rather than accumulating, the timing and sequence, not just overall level, of withdrawals and market returns are critical. Large portfolio declines in the early years, or declines corresponding with large withdrawals, can be especially painful. Avoiding risk altogether isn’t a viable strategy for the majority of retirees, but planning for difficult markets will make them more manageable when they arrive.