Why 2022 was a dangerous time for retirement — and what you can do about it – CNBC | Vette Leader

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It’s a scary time for new retirees.

Stocks have plummeted this year. Bonds, traditionally used as ballast when stock prices falter, have also come under pressure. Both trends are of concern for seniors who rely on investments for their retirement income. High inflation also means retirees need more income to afford the same items and make ends meet.

“It’s a pretty bad combination that’s relatively rare,” said David Blanchett, head of fixed income research at PGIM, Prudential Financial’s investment management arm, of the three-pronged challenge.

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“2022 was a dangerous time for retirement,” he added.

However, there are steps retirees – and those planning to retire soon – can take to protect their nest egg.

Why it matters

The S&P 500 Index is down nearly 17% in 2022. The index fell into a bear market at one point on Friday (meaning the US stock index fell over 20% from its recent peak in January) before recovering somewhat.

The Bloomberg US Aggregate Bond Index is also down over 9% this year. Bond prices move inversely with interest rates, a dynamic that has stressed bond funds as the Federal Reserve hikes interest rates.

Investors are most vulnerable to market shocks in the early months and years of retirement.

This is due to the risk of “return sequence”. Someone who withdraws money early in retirement from a declining portfolio is at greater risk of exhausting their nest egg too soon than a retiree who suffers a market downturn years later.

When the market pulls back, it means investors have to sell more of their investments to earn income. That depletes savings faster, leaving less room for growth when things recover, and hampering a portfolio that’s meant to last for several decades.

The “sequence” — or timing — of investment returns is important.

Consider Charles Schwab’s example of two new retirees with $1 million portfolios and $50,000 annual withdrawals (adjusted for inflation). The only difference is that each suffers a 15% portfolio loss:

You have a 15% decline in the first two years of retirement and a 6% gain every year thereafter. The other has a 6% annual gain for the first nine years, a negative 15% return in years 10 and 11, and a 6% annual gain thereafter.

If you plan for 30 years [of retirement]those first few years could be really important in terms of what you end up seeing for your bottom line.

David Blanchett

Head of Retirement Research at PGIM

The first investor would run out of money after 18 years, while the other would have about $400,000 left over.

“If you plan for 30 years [of retirement]Those first few years could be really important in terms of what you end up seeing for your bottom line,” Blanchett said.

Of course, some retirees are more vulnerable than others.

For example, a retiree who gets all or most of his or her income from Social Security, pensions, or annuities is largely unaffected by what happens in the stock market. The amount of these funds is guaranteed.

Also, for someone retiring at an older age, return risk is likely to be less severe since their portfolio doesn’t need to last as long. Even a retiree who has saved far more money than is needed to support his lifestyle is unlikely to affect it much.

What to do

If new retirees are nervous about the current market situation, there are a few ways they can reduce their risk.

For one, they can withdraw their spending and thereby reduce withdrawals from their nest egg. For example, a supporter of the “4 percent rule” strategy might choose not to adjust for inflation – although there are many different schools of thought when it comes to spending in retirement.

Regardless of the strategy, reducing withdrawals puts less strain on the investment portfolio.

“Does that mean you can’t go on a fun cruise or vacation? Not necessarily,” Blanchett said. “It requires potentially thinking more about trade-offs depending on how things are going.”

Similarly, retirees can reorganize where their withdrawals come from. For example, to avoid pulling money from stocks or bonds (categories that are in the red this year), retirees can pull from cash instead.

This leads back to sequence risk and trying not to extract money from assets that have fallen in value. Withdrawing from a bucket of cash while waiting for other assets to (hopefully) recover will help achieve this.

“You don’t want to sell stocks or bonds in this environment if you can afford to,” said Christine Benz, Morningstar’s director of personal finance.

However, retirees may not have cash on hand for several months or years. In that case, they can draw from areas that aren’t as hard hit as others — for example, perhaps from short- or medium-term bond funds that are less vulnerable to rising interest rates.

Workers who have not yet retired (and worry about having enough money to do so) may choose to work a little longer, if they are able. Or they can consider earning a side income in retirement to take less of a strain on their nest egg.

Reducing the demands on your investment portfolio is one of the most important things you can do, Benz said. For example, every year when Social Security recipients delay claiming full retirement age, they receive a guaranteed annual increase in their benefits of 8%. (However, this 8% increase stops after age 70.) Seniors who can delay receive a permanent increase in their guaranteed annual income.

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