Retiring into a recession? What soon-to-be retirees should know about retiring during a market downturn

If you’ve been watching your retirement portfolio for the past few months, you’ve probably noticed the value of your nest egg taking a dramatic dip. From the beginning of 2022 through Nov. 2, the value of the S&P 500 slipped more than 21%, the Dow Jones fell over 12% and Nasdaq dropped by almost 33%. And the stock market isn’t the only aspect of the economy that’s hurting soon-to-be retirees. In recent months, inflation has remained at record-high levels. The Fed has responded by raising interest rates and many are predicting a global recession as companies and consumers pull back on purchasing and borrowing in response. As people look to their future retirement, it may seem less than optimistic. If you’ve spent the last few decades of your life stashing away money for your golden years, the recent market downturn, however, doesn’t mean that your effort has been all for not.

Saving for retirement 101

Most people have three primary sources of income in retirement: personal retirement accounts (401(k)s and IRAs), pensions and Social Security. Most people, however, will primarily end up relying on income from their retirement accounts. Most personal finance experts recommend saving in both a 401(k) and an IRA, be it a traditional IRA or Roth IRA. Select ranked Charles Schwab, Fidelity Investments, Vanguard and Betterment as companies offering some of the best individual retirement accounts. Most companies don’t offer employees pensions anymore, and Social Security typically only replaces a small portion of people’s pre-retirement income. According to the Center on Budget and Policy Priorities, a person with average lifetime earnings would only earn 37% of their preretirement income through Social Security benefits. This means that the responsibility for saving for retirement falls squarely on the individual. Generally, personal finance experts recommend that retirees aim to save 25 times their annual living expenses. In other words, a person who has annual living expenses of $40,000 should aim to save $1 million for retirement. In retirement, the individual would withdraw no more than 4% of their retirement portfolio annually, while adjusting for inflation. However, this rule has fallen out of vogue as peoples’ life spans get longer, and the cost-of-living increases. Since the 4% retirement rule rests on assumptions about how long people will live, portfolio allocation and historical market returns, it’s not a one-size-fits all rule. “This is why planning is so helpful, so you don’t need to use rules of thumb,” says Douglas Boneparth, President of Bone Fide Wealth. In fact, Richard Sias, a Professor of Finance at the University of Arizona, recommends a much lower withdrawal rate. He found that people would actually need to withdraw a meager 2.26% of their portfolio (assuming a 60/40 stock and bond allocation) to have a 95% chance of success. In other words, if you annually withdrew 2.26% of your retirement nest egg, you would have a 1 in 20 chance of running out of money before the end of retirement. And if you’re worried how the recent market downturn will affect your withdrawal rate, researchers have looked to history to see how seniors fare when retiring into a bear market. T. Rowe Price looked at people’s retirement portfolio performance after retiring into bear markets in 1973, 2000 and 2008, finding that portfolio values eventually rebounded or exceeded their original value around 10 years later. The researchers note the importance of flexibility in response to market downturns. Retirees should use a withdrawal rate that changes based on factors like inflation, market fluctuations, and changes in individual spending needs to ensure long term success.

Is it time to change the allocation of your portfolio?

If you’ve been maintaining a diversified retirement portfolio with 60% allocated towards stocks and 40% towards bonds, you’ve probably noticed both asset classes taking big hits. From the beginning of the year to the end of September, the value of a 60/40 portfolio fell 20%. And there’s no expert consensus about what you should do with your portfolio. If you’re a skilled investor, Boneparth suggests taking advantage of the current downturn by purchasing stocks or stock funds while they’re low. But of course, if the market hasn’t bottomed yet, you’re taking a risk. “The reality is the market probably will go down more,” says Mark Pitre, Principal at California Financial Advisors. “Because we believe there’s going to be a better opportunity to rebalance over the next year, two years or three years.” And since interest rates have an inverse relationship with bonds, it may not be a good idea to pour all of your money into bonds either. When interest rates rise, bond prices fall, so the Fed’s upcoming rate hikes mean existing bonds will be worth less in the future. Shannon Saccocia, Chief Investment Officer at SVB Private, recommends that investors refrain from making big changes to their portfolios without consulting a financial planner and try to stick with their long-term financial plan.

Bottom line

Most importantly, there’s no one-size-fits all advice for investors nearing retirement. Your retirement plan needs to account for many factors, whether it’s how long you expect to live or how risky your portfolio is. Being flexible in how much you withdraw from your nest egg may be key to ensuring long-term success. This might mean withdrawing less in market downturns and more when the cost-of-living increases. And if you’re thinking about changing your portfolio allocation now, you’ll want to make changes based on your long-term plan. With both stocks and bonds performing poorly, it might not be the best time to make significant changes to your portfolio, especially if the market continues to plummet.