After more than 10 years of a rising bull market, it’s been easy for advisors and clients alike to fall prey to recency bias — the tendency to assume that markets and the economy will keep chugging along at the same rate. Recent stock market volatility fueled by coronavirus concerns provides a good reminder that things can change quickly. When change comes, your clients who are living in the years just before or after retiring will stand to lose the most.
“Risk management is most critical for investors near, at, or just past retirement, especially in this market environment,” says Clark Richard of Vineyard Global Advisors in Denver. “It’s a little like Mt. Everest, where the greatest risk is in the time period just before and after a climber summits. Likewise, in retirement planning, you need portfolios designed to avoid slipping and falling around those pivotal years.”
So why do the years immediately before and after retirement have such a disproportionate impact on future wealth? The answer has to do with sequence of returns risk, which refers to the possibility that low returns in early retirement deplete a client’s portfolio just when they start spending their nest egg. In this situation, the portfolio takes a hit not only from declining asset values, but also from withdrawals. That one-two punch erodes the client’s capital base, leaving fewer shares to participate in an eventual market rebound. Retirement expert David Littell warns that “Negative returns in the first few years of retirement can add significantly to the possibility of portfolio ruin.”
Why the Risk Is Higher Today
The International Monetary Fund expects U.S. GDP growth of just 2% in 2020, and global growth of 3.3% — a significant decline from last year. An escalation in geopolitical risk could easily drive those projections lower. In addition, the prospect of below-normal growth in an environment of high stock valuations and low interest rates opens the possibility of an eventual market correction, underscoring the need to prepare client portfolios now.