I’m retiring and plan to keep two years’ worth of living expenses in cash and invest the rest of my retirement savings in stocks. The idea is that I’ll be able to earn stocks’ high long-term returns and not have to worry about selling stocks at a loss in a bear market since no bear market lasts more than two years. Do you think this is a good plan?
Over the years I’ve heard lots of reasons from older investors and retirees why they believe they’ll be just fine investing their entire nest egg in stocks. Some have told me they’re confident that market downturns won’t fluster them because the market has always bounced back from even the steepest slides. Others claim that their Social Security benefit is the equivalent of a big stake in bonds, so it acts as a counterweight to their all-stock portfolio. And now you suggest an all-stocks retirement portfolio makes sense since your cash reserve will allow you to avoid selling shares during a bear market.
But while I agree that these rationales for loading up on stocks may be valid to some extent—indeed, none other than Warren Buffett has recommended investing 90% of one’s nest egg in a stock index fund and 10% in short-term government bonds—I’m still skeptical that investing all or even nearly of your savings in stocks is a viable strategy for most retirees, even if that plan includes a hefty reserve for living expenses.
Why? Simple. I’m not convinced that most investors, and especially those near or in retirement, fully appreciate the emotional and psychological impact of watching the value of their stock holdings dwindle during a severe and prolonged market setback.
It’s one thing when the market has been surging for more than seven years and stock prices are at or near all-time highs to say you can handle extreme volatility or that you have the steely nerves to wait out a bear and not bail out of stocks at or near a market bottom. But I’ve found that people tend to be less certain about their conviction to hang in when the you-know-what really hits the fan and stock prices are tumbling, investors are panicking, pundits are predicting Armageddon and all the financial news is bad and seems to be getting worse. It’s during such dark times that investors understand the concept of “capitulation,” which describes what happens when even the most gung-ho investors lose hope of a rebound, hoist the white flag and begin selling stocks however low the price.
As for your contention that your two-year cash reserve can carry you through any downturn since no bear market lasts more than two years, well, that’s not quite correct. It’s true that the 20 bear markets (defined as a drop of 20% or more in stock prices) since 1929 have lasted roughly one year on average, according to this recent Yardeni Research report on bull and bear markets and corrections. But two have lingered on for more than two years—31 months and 26 months for the bears of 2001-2002 and 1930-1932 respectively—and five others have lasted a year and a half or so.
And while your question focuses solely on duration, you also need to consider the severity of the setback, or how far you might see the value of an all-stock portfolio swoon. On average, stock prices have fallen by roughly 37% over the course of those 20 bear markets, but the drop can be much steeper. The granddaddy of them all (so far, at least) was the 1930-1932 bear, which saw prices nosedive a staggering 83%. But the most recent bear market that stretched from late 2007 to early 2009 wasn’t exactly a slouch, with stock prices dropping 57%.
Those sorts of setbacks can be upsetting for any investor. But when you’re in retirement and largely unable to replenish your shattered nest egg with additional savings, such losses can be even more unnerving, and possibly make it harder for you to relax and enjoy retirement.
My aim here isn’t to try to dissuade you from your plan by citing a bunch of scary statistics. Rather, I want you to consider whether it’s realistic to assume you’ll be able to calmly spend through your cash reserve while stock prices are sinking yet remain confident that stocks will rebound on schedule within two years. After all, it’s not as if people knew back in late 2008 after more than a year of declining prices that the market would start to rebound in March 2009. Indeed, skittish investors were still pulling money from stock mutual funds.
And while reviewing past bear markets can give you a sense of how deep past setbacks have been and how long they’ve lasted, that doesn’t mean you can predict how future downturns will unfold. For all we know, the next bear that arrives could be a little cub with a soft growl and a modest bite—or it could be a big old hairy grizzly with a ferocious roar that mauls investors’ portfolios.
Rather than embarking on an extreme investing strategy—and I do think a 100% stock portfolio in retirement is extreme—I recommend a different approach: Create a comprehensive retirement income plan that takes into account how much annual income you need to cover your expenses (which you can estimate using this BlackRock Retirement Expense Worksheet); how much of that yearly income must come from your savings; and how much you can reasonably withdraw from savings each year without incurring too big a risk of running through your nest egg too soon (which you can gauge using this retirement calculator).
As for investing, your primary goal should be to arrive at a stocks-bonds mix that can provide solid returns without exceeding your tolerance for risk—in short, a portfolio capable of sustaining your savings withdrawals throughout retirement and that you’ll be able to stick with even through a deep and prolonged bear market. This risk tolerance-asset allocation questionnaire can help you create such a stocks-bonds mix.
Finally, when you have a stocks-bonds blend that seems right for you, you can plug that mix, as well as others more conservative and more aggressive, into that retirement income calculator I mentioned to see how your chances of maintaining a given level of withdrawals from your nest egg go up or down with different stocks-bonds allocations. I think you’ll find that, as long as your planned withdrawals are reasonable, you don’t have to take big investing risks to ensure that your savings last as long as you do.