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Market dips and superannuation: risk or opportunity?

Ruth Saldanha  |  14 Nov 2018Text size  Decrease  Increase  |  
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Many indices fell sharply in October, as the Nasdaq and S&P 500 fell 9 per cent and 5.5 per cent respectively, but even investors approaching retirement shouldn't panic.

For long-term investors, these dips could prove invaluable buying opportunities, especially for those with a much longer time horizon, as buying on these dips could give investors access to cheaper stocks with long-term value to gain the benefits of compounding.

But for investors very close to retirement, or those recently retired, these dips could cause some amount of stress, as investors could see their retirement portfolio erode in value. This group usually has to make this portfolio last through retirement, maybe as long as 30 years, so seeing the drop could be scary.

"This is the group where I would say that usual advice of 'stay the course' doesn't always apply. If people have been getting close to retirement or they're retired, and they have not been making their portfolios a little bit more conservative as time goes by, some adjustments may actually be in order. I think it's well worth taking a look at a few elements of the portfolio construction as well as the retirement plan at this life stage," says Christine Benz, director of personal finance at Morningstar.

What should retirees do when the markets dip?

“I'm a big believer in letting anticipated portfolio withdrawals drive how much pre-retirees and retirees hold in various asset classes. Let's say, for example, that someone is a couple of years away from retirement. In that instance, they might want to hold something like eight to 10 years of those withdrawals in safer assets like cash and mainly bonds. That way even if stocks come down and stay down for the next decade, the new retiree won't have to worry about selling stocks when they're in a trough. The rest of the portfolio can go into higher-returning (but also more volatile) assets like stocks," Benz advises.

To use a simple example, let's say a pre-retiree has a $1 million portfolio and intends to spend $35,000 from it each year. In that case, she would have roughly US$350,000 (35 per cent of assets) in bonds and the remainder (65 per cent) in stocks.

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"If he or she is actually retired, then I like the idea of parking a few years' worth of portfolio withdrawals in cash," Benz notes.

Benz recommends that retirees stand ready to reduce their withdrawals in deep market downdrafts; ideally their plans wouldn't be so tight that some cutbacks to spending would necessitate big changes to their standards of living.

"Since the recent market volatility hasn't led to big losses in most cases, I would instead use it as a motivator to check up on spending. It's easy to grow comfortable with enlarged portfolio balances ("the wealth effect"), and retirees may not have been monitoring their spending too closely over the past several years. The recent market volatility can be an impetus to run a tighter ship on the spending front," Benz said.

The recent market volatility has not been severe enough to warrant any drastic action. But what should retirees do if the market starts to trend sharply downward?

"Should a substantial market correction or even a bear market materialize, that could, realistically, force some pre-retirees to re-think their retirements a bit," Benz said, adding that in those circumstances, retirees or soon-to-be retirees might have to ask themselves tough questions, like can they continue to work a few more years, or work part-time, so that their portfolios can recover?

Or could they ponder some lifestyle adjustments in the early years of retirement to reduce spending--for example, downsizing to a cheaper home or cheaper part of the country?

Finally, should soon-to-be retirees consider any other forms of diversification beyond stocks and bonds to protect themselves?

"Stocks, bonds and cash together can provide a lot of diversification benefit. One other broad category worthy of consideration as retirement approaches is investments that protect against inflation. After all, if you're no longer earning an income, you're no longer going to be getting automatic inflation adjustments from your paycheck; you'll need to insulate your portfolio withdrawals from rising prices. Inflation-protected bonds are a key category to consider. You might also consider real estate securities, which tend to perform pretty well in inflationary environments, and/or commodities," Benz suggests.

 

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is senior editor at Morningstar.ca

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