It was late September 2008. I was in Provence with my husband and some extended family, enjoying my sabbatical in our perfect little rented house. But things weren't all that tranquil. The market was tumbling, and one of the family members who had joined us was in a state of panic. Though she was still several years from retirement, she was convinced that she wanted to sell all of her stock holdings. The news about the markets and the state of the global economy seemed to be going from bad to worse by the moment.
Finally, my husband broke through.
"Are you getting ready to retire? Will you need your money soon?" No and no, she answered.
"Then stop worrying and enjoy your vacation!" And amazingly, that seemed to break the spell.
We snapped off the TV, with its dire news about the market's drop, and our relative ignored the market and stood pat with her portfolio.
That sounds like a success story, and it was. But I wouldn't necessarily give that same family member the same advice today, in the wake of the market's recent swoon. No, I don't have any insight into whether the current market volatility will be a short-term blip or the beginning of something really bad. But I do know something about my relative: Now she is ready to retire and will be drawing upon her portfolio for living expenses. That means that the approach that made sense for her 10 years ago--don't sell any stocks!--may in fact be ill-advised today. If she hasn’t taken steps to reduce her equity exposure in the interim, cutting the stake now in favor of safer investments could, in fact, be precisely the right course of action.
Selling into a Downturn isn't always a bad idea
The fact that investors can vary so much in their spending horizons is the key reason why I often cringe when I hear one-size-fits-all recommendations during volatile markets. Even as well-meaning market observers exhort everyone to "stay the course," not everyone should, actually. People getting close to retirement or those who are already retired are courting serious risks by standing pat with too-aggressive portfolios.
For one thing, even hands-off portfolios have a way of becoming more aggressive over time. Take, for example, a portfolio that was 60% S&P 500/40% Bloomberg Barclays Aggregate Index 10 years ago. Even if an investor hadn't been shoveling money into strong-performing stocks over the ensuing decade, that portfolio would still be 80% equity today. An 80% equity/20% bond portfolio would be 90% stock/10% bond today.
That ever-more aggressive positioning isn't a problem for people who still have many years until retirement. In fact, it's desirable, provided the investor knows herself to not become unduly rattled (and therefore at risk of panic-selling) amid declines. While it's not a given that stocks will outperform safer asset classes over long time periods of time, market history suggests that's a reasonable bet. When you're young (and by that I mean under 50), not taking full advantage of the historical outperformance of riskier asset classes is a bigger risk than being too conservative.
But those risks flip once you get close to and enter drawdown mode. At that life stage, you're much more vulnerable to what retirement planners call sequence-of-return risk. That means that if you encounter a calamitous equity market early on in retirement and need to spend from the declining equity portfolio, that much less of your investments will be left to recover when stocks finally do. Your only choice to mitigate sequence-of-return risk--assuming your stock portfolio is in the dumps and you don't have enough safe investments to spend from--will be to dramatically ratchet down your spending. Needless to say, that's not something most young retirees are in the mood to do.
And here's another thing. Your past behaviour in market declines isn't always a great indicator of how you're apt to behave in the next big downturn. Even if you sailed through the 2007-2009 market meltdown without undue worry or panic-selling, the next downturn could prove more visceral if retirement is closer at hand and starting to seem like a realistic possibility. It's not fun to see your portfolio drop from $500,000 to $225,000 when you're 45. But it's way worse to see your $1 million portfolio drop to $450,000 when you're 55 and beginning to think serious thoughts about the when and how of your retirement. The losses are the same; the ages are different. Retirement is no longer an abstraction, so it stands to reason that you could be at greater risk of selling yourself out of stocks at the worst possible time.
Of course, people nearing or in retirement should be sure to hang on to some stocks, too. After all, returns from cash and bonds are unlikely to keep up with inflation over time. To help preserve a portfolio's purchasing power, even older retirees need the growth potential that can accompany stocks.
This article initially appeared on Morningstar.com
