Retirees Cannot Afford to Buy and Hold When in Retirement

It’s that time when all the big fund managers roll out the long term stock market charts showing a trending stock market over the last 100 years. It’s a good ploy because over the long term the stock market goes up and “lo and behold” the advice given to you is to buy and hold for the long term. QED.

Well not so fast because you need to ask yourself:Dow Jones Industrial Average 1970-2008

  • Are you accumulating your nest egg and so will not need it to live?
  • Or are you relying on it to provide some or all of tour retirement income?

These are two totally different strategies. (larger image of DOW below)

What is also important is to distinguish between:

  • The Long Term of the stock market, which is forever.
  • The long term of your Retirement, hopefully 25-30 years at least.

In relation to the stock market your horizon is short term not long term. Your retirement is a very small slice of the long term trend of the stock market. The fund managers tell us that over the short term the stock market can be very volatile. Again this is true and a real danger for us Baby Boomers if the slice you take just happens to be volatile.

What they don’t point out is that the day you retire your retirement nest egg becomes very vulnerable to those short term stock market fluctuations if you are drawing down your nest egg for income.

When you retire you need to consider yourselves as starting your investments from year zero once again but with a lump sum (your nest egg) already fully invested.

Therefore you can be subject to any short term volatility of the stock market just when you stop adding to your nest egg and start taking a pension from it.

In 2000-2003 this short term volatility decimated many Baby Boomers’ retirement nest eggs just as they began to retire. In fact some Baby Boomers lost up to 40% of their retirement nest egg at that time and so did not retire.

But that is not the only problem.

Another problem is to recover the losses and start to make some returns on your investments to maintain your capital at least in the early years of your retirement. The fund managers tell you to invest in the stock market using a buy and hold strategy to ensure you keep up with inflation and so as not to miss out on stock market returns needed to maintain your capital.

Unfortunately when you decide to retire you are making the biggest market timing decision of your life. Everything changes for you because you are no longer accumulating your nest egg. Any large loss can seriously erode the ability of your nest egg to make enough returns to last you through your retirement.

Using the chart below just look at the long term stock market returns below and imagine if you retired in;

Dec 1972

In Dec 1972 the Dow was at 1,000. By 1974 it was down to 557, a 42% loss. It took until August 1982 to reach 1,000 again. So it was flat for 10 years with no capital gains whatsoever. Inflation was in double digits through much of that period. So how did the stock market provide you with returns and protect your nest egg against inflation then?

Aug 1987

In August the Dow was at 2,685 and by Dec 1987 it had lost 28% of its value to settle at 1,913. Admittedly it only took until Dec 1989 to exceed 2,685 the first time but 1990 to continue on its up trend. Luckily inflation was lower but you made no capital gains for 2-3 years, which is a big problem if you had retired at that time.

Jan 2000

The Dow was 11,722 in January 2000. In Sept 2001 it dropped to 8,235, a lost of 30%. Then it recovered to 10,572 by Mar 2002 and you probably thought the worst was over. Not so, by Feb 2003 it was down again but this time to 7,864. It took until Oct 2006 to get back to the January 2000 level.

Jul 2007

The all time high of 14,280 was reached in July 2007. By July 2008 it is down to 11,659, a loss of 18% from the high. If you just got your money back from 2000, you just got whacked again.

All we are talking about here is getting back your capital based on the stock market high before the crash. Inflation is not accounted for here.

Logarithmic charts are used for long term charts. The Chart includes dividends and splits.

DOW JONES 1970 to 2008

But inflation is not the only problem. Let’s assume the following

  • inflation – 3% say
  • fees and charges – 2% say
  • pension – 4% say

That means you would have to actually be making 9% back on your investments in each of those early years following a market crash just to keep the purchasing power of your pension and maintain the value of your capital.

Since 2000 the Dow has gone sideways and maybe made about 2.5% a year at best.

So you should be able to now see how hard it is to protect your nest egg in retirement in those early years if the nest egg suffers a large loss at the start of your retirement.

It should also be obvious how hard it is to recover the losses, even if the market goes up, when you have to deal with inflation, fees and a pension withdrawal. Taxes too affect it but because of their complexity I have left them out of this Post.

This is why Buy and Hold does not work for Baby Boomers in retirement and when you are taking a pension.

It is also why you need to reduce the fees down as much as possible for any investments you make (unless you are lucky enough to find a wealth manager who has consistently got good returns).

So please get with your trusted financial adviser and put in place a strategy to avoid large losses to your nest egg in future, minimize fees and find ways to handle inflation and taxes if opportunities present themselves.

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