Market volatility poses a major risk to young retirees. Here’s how to prepare

If you’re ten years away from retirement, the current stock market volatility can be a good reminder of the risk ahead for your nest egg.

Although stocks tend to offer the best opportunity for long-term growth despite their ups and downs, a continuous market decline leading to retirement can be a problem if you need to use those assets when the price drops. That can permanently reduce how long your career will take, said certified financial planner Mike Casey, founder and president of AE Advisors, Alexandria, Virginia.

This happens “by forcing investors to sell depressed assets and reducing the capital available for recovery,” Casey said.

This problem is known as “sequence of returns” risk, which means that the sequence, or sequence, of your gains or losses over time is not important when closing your investment.

“The best way to deal with the sequence of return risk is to put a plan in place before retirement,” said CFP André Small, founder of A Small Investment in Houston. “I usually recommend clients start planning for succession risk at least three to five years before they retire.”

Since the February 28 start of the war in Iran, the major stock indexes have been hovering around low amid high oil prices, fears of a price drop and uncertainty about when the war in the Middle East will end. Year until Thursday, the Standard & Poor’s 500 index – a broad measure of how US companies are doing – was down 4%. The Dow Jones industrial average closed 3.1% for the year, and technology is heavy Nasdaq Composite Index decreased by about 7%.

However, over the past year, the S&P jumped more than 17%, the Dow gained nearly 13% and the Nasdaq rose 19.8%. Although it is impossible to predict where the stock market will go from here, uncertainty is expected.

For long-term savers – those whose retirement is years or decades away – the ups and downs of the stock market often don’t matter because their portfolios have time to recover before they are relied on for cash. For those investors, “the degree of return risk … is not such a big issue,” said CFP Frank Maltais, a financial advisor for Fidelity Investments in Portland, Maine.

For young retirees, however, it can make a big difference, Maltais said.

“If you retire in a poor market, that can reduce your nest egg over time, especially if you don’t reduce your withdrawals during a down market,” Maltais said. “On the other hand, if you have a strong market before you retire, that can put the wind at your back.”

To illustrate, according to a recent report from Fidelity: If a retiree starts with $1 million and withdraws $50,000 annually, and there is a string of good earnings before retirement followed by a subsequent bear market, the career will be worth more than $3 million after 30 years. On the other hand, if there are negative earnings before retirement, and following a bull market, the portfolio will be over in 27 years.

Attrition rate is a key component of succession risk, Maltais said.

He used an example from the early 1970s: If a 65-year-old retirees around 1972, ahead of them was the bear market of 1973-1974, when the S&P dropped 48%. “That was a time when you had very high inflation, we had an oil crisis and we had political instability,” Maltais said.

“Traders who had balanced portfolios that had different asset classes – stocks, bonds, cash – and were pulling 4%, would have seen that last job,” he said.

But someone who had to resign was risking obsolescence — and the higher the rate of withdrawal, the earlier the career would have ended, he said.

It’s also important to know exactly what your retirement expenses will be, advisers say, as well as your sources of income — that is, Social Security, pensions, annuities, part-time work. This helps determine how much of the portfolio you will need to use in any given year.

“Understanding spending needs is the most important thing to start reducing this [sequencing] risk, rather than starting with portfolio allocation,” said CFP Matthew McKay, director of investments for Briaud Financial Advisors in College Station, Texas.

“The reason we start there is to understand, how we need to build a cushion in it [asset] distribution,” McKay said.

“Once we have that number, we create a base of assets that depend on the money, which is intended to be used for those first years of spending money, to make sure that we have time to see the market move and maybe recover if there is a decrease, without needing to sell in the weakness,” he said.

Maltais said that the withdrawal rate can influence how much the portfolio should be in stocks. For example, a person with sufficient other sources of income can only expect to need 1% of their portfolio each year. He said that the investor can be more aggressive in his investment compared to someone who expects to lose 6%.

One way to plan against risk is to have a solid emergency fund, Maltais said.

“Try to have one to two years’ worth of expenses in the money,” he said. “That way if there is an unexpected fall, [retirees] they don’t have to sell their work down too much if unexpected costs happen.”