What if the Market Crashes Right After I Retire?

“Good times, bad times, you know I had my share” – Led Zeppelin

Should You Sell?

In an extended retirement there will be many good times and bad times in the market.  The bad times can be really bad–between October of 2007 and March of 2009 the S&P 500 fell 57%.  Around that time,  I spoke to 2 friends who retired shortly before the stock market crashed.  One seemed really smart because he’d sold all of his stocks when he retired, while the other friend was spending hours staring at his computer screen in a daze.  Obviously, the first friend had the right approach, or did he?

No, he didn’t.  There’s a difference between a good decision and a good outcome; sometimes we get lucky.  Since 1970, stocks have had a 7.9% real (after inflation) return (all multi-year returns in this post are the compounded average growth rate)  while bonds have had a 3.0% real return and money market have enjoyed only a 1.3% real return.  Unless your name is Marty McFly and you have a “Back to the Future” time machine, you have no way of knowing that the stock market is about to crash.  The more likely outcome when you sell all of your stocks is you get mediocre returns going forward that won’t support your lifestyle.

What if everyone says the stock market is expensive, shouldn’t you sell all of your stocks then?  In December of 1996 Alan Greenspan, Chairman of the Federal Reserve, gave a famous speech expressing concern about “irrational exuberance” in the stock market.  The  return for a 60% stocks/40% bonds portfolio the year after that speech was 19.6%. There were two more good years after that before the 2000 stock market crash.  And yet even taking the crash into account, if you look at the performance for the above portfolio from 1997 onward it had a 5-year return of 7%/year and 10-year return of 5.4%/year.  Similarly, anyone who held a healthy portfolio of stocks and bonds through the turmoil of the 2007-2009 downturn and kept holding them has enjoyed a very positive return today (5.7%/year).

Hacks to Help You Sleep at Night

So if the friend who sold all his stocks was wrong (but lucky), was the stressed out friend right?  No, retirement should be about eliminating stress from your life, not adding to it.  Here are some financial and psychological hacks to avoid getting stressed.

First, never put money in the stock market that you need in the next five years.  Stocks have had a great return in the long-run, but sometimes a terrible return in the short run.  On the other hand, you need to go back to the 1970s to find an extended period in which your 60/40 portfolio had a negative return over a 5-year period.  If you’re buying your first house (probably not true for retirees!), paying for college, or some other major expense, then it’s best to keep that money outside of the stock market.

For your retirement expenses, you want to avoid having to sell stocks when they’re down.  That means you will be drawing down your bonds during a downturn (which also helps to re-balance your portfolio), but there are also periods when stocks and bonds are both down due to rising interest rates.  I solved for this problem by investing in bond ladders so I wouldn’t have regrets about about giving up my job, especially in my early years of retirement.

Here’s how that works for me:  I first calculated my investment income (e.g. dividends and interest, but not capital gains).  Then I compared that to my estimated living expenses and determined the shortfall.  That shortfall is what I invested in bond ladders for the next 5 years.  A bond ladder consists of either individual bonds or a “defined maturity bond fund” in which all of the bonds in the fund mature in the same year.  I have one bond fund maturing in 2020, another in 2021 and so on.  In this way I eliminated the risk that the bonds would go down in value as I just hold them to maturity.  Overall, this strategy gives me 5-years to ride out a bad downturn without needing to sell stocks or bonds when they’re down in value.  If the downturn lasts more than 5 years I can draw down by cash position from 5% of my portfolio to 2-3% to buy me more time. Also, while stocks may stay down for more than 5-years, bonds should not and I can always sell more bonds to avoid needing to sell stocks when they’re down.

That’s my financial hack and here’s my psychological hack.  Stop obsessing over the stock market!  I moved the stock app from the first screen to the third screen of my iPhone so I’m not tempted to look at it frequently during the day.  I’ve stopped updating my net worth spreadsheet regularly and now only do so every 3-6 months.  Once you know you have a good game plan in place, it’s important not to second guess yourself.

Let me know about any financial or psychological hacks you’ve developed for stock downturns!

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