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Utilizing a Retirement Decumulation Strategy
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Navigate Market Crashes with Retirement in Mind
Published February 21, 2018
The market performing poorly reminds us that we need to be cautious with the risks we take so we navigate market crashes well. Defend against recency bias by having a financial portfolio that will do what you need it to do through all kinds of market cycles.
- Anyone investing for retirement needs to know how to navigate market crashes.
- The best way to navigate market crashes is to have a diversified portfolio that does what you need in all market cycles.
- The Personal Pension and other income annuities provide some of that needed diversification.
Times of market upheaval (like what we saw in early February 2018) serve as a stark reminder that the stock market puts real money at risk. Just ask those who had invested in banks and subprime mortgage originators around 2008.
It’s at times like this where we need to navigate market crashes that we tend to get the most interest in the Personal Pension and other income annuities we provide access to. All of a sudden a guaranteed (subject to the claims-paying ability of the insurer) paycheck in retirement with returns similar to bonds doesn’t look so bad.
Navigate Market Crashes: Recency Bias
Ideally, people would remember the virtues of diversification out of the stock market both in good times and bad. And, specifically, they’d remember that a guaranteed outcome where the payouts you’ll receive are insured is such a valuable thing to have.
But it’s human nature to suffer from recency bias. Recency bias is the idea that we overweight things that have recently happened and this can lead to irrational behavior that gets compounded by a herd mentality. And right now recency bias means that low-risk double digit stock market returns are the norm.
Given this shortcoming in us humans, it means there’s a fine line between fear-mongering and reminding people what 1987’s Black Monday, the Dot Com Crash or September 2008 were like. We’d prefer if people had these events in mind all the time, but the reality is that they often are forgotten.
The best defense against recency bias is to have a financial portfolio that will do what you need it to do through all kinds of market cycles — stock booms and crashes; inflation and deflation; boom times and recessions.
And it also means protecting against the array of personal scenarios that you could encounter — poorer than expected physical or mental health; or, unexpected longevity that causes you to live longer and be more active in retirement than expected.
But that kind of diversification and protection is a hard thing to convince yourself to implement — diversifying out of the stock market means accepting lower expected returns since in an efficient market, less risk should (and often does) mean lower returns.
There are two ways to think about retirement portfolio performance that we think make sense:
- Returns per unit of risk. Think about it this way — if an investment offered a 10% return with 99% certainty, you’d probably take that over an investment where you have a 50% chance of getting an 11% return and a 50% chance of no return. Or at least, that’s what you should do if acting rationally.
- The types of risk you’re protected against. Is your portfolio well protected from inflation risk? Longevity risk? Market risk? Sequences of returns risk? Concentration risk? Counterparty risk? All are important risks to at least consider protecting against, especially when it comes to your retirement portfolio.
Navigate Market Crashes: Risk and Retirement
I often hear the blanket advice that, when investing for retirement, you should take a long-term approach. That’s true if you’re young — being 3 or 4 decades from needing the money means you can and should be taking all kinds of risk in the hope of higher projected returns.
But what about if you’re about to retire or in retirement already? Or even if you’re less than 20 years from retirement? Does this advice still apply? Usually not. If you need the money in 2-5 years, let’s say, you’re not longer a long-term investor at all. Another 2008 will significantly impair your ability to maintain your standard of living in retirement.
Those who suffered most from 2008 were those who sold at the lows out of fear and those who sold at the lows because they needed that money to fund their retirements.
Your ability to think long-term is a function of two things: (1) when you need the money you’ve saved and (2) how painful suffering losses will be on the money you’ve put at risk.
Navigate Market Crashes: In Conclusion
Heavy stuff. What does it all mean? No one has all the answers, but here’s what I believe:
- It makes sense to be prepared at least for the range of scenarios that have happened in the financial markets in the past.
- The best time to act is before those events happen.
- A singular focus on portfolio returns will lead to tears.
- If investing for retirement, you’re only a long-term investor if your retirement is a couple decades away.
- Market declines are worst for those who sell low. Avoid it at all costs.
The Personal Pension or other income annuities can be an important component you can use to protect against risk that your market portfolio doesn’t (specifically longevity risk and market risk).
The products on our platform provide guaranteed income of a set amount that starts a pre-set date. In a post-employer pension world, guaranteed income is harder to come by and that’s where we come in — unbiased, independent guidance on the entire annuity market.
Click below to see what diverting some of your annual savings into a Personal Pension can guarantee you in annuity retirement income.
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