Investors around the globe have seen their retirement savings shrink significantly courtesy of the global financial crisis. But the group of investors who perhaps have more right than any other to curse their luck are those people who have retired in the past 12 months. Now retirees who planned their super contributions and retirement with the help of a financial adviser ought to have been well aware that investment markets will - from time to time - have negative years and occasionally severe ones at that.
But even armed with that knowledge few could have been prepared for the depth and severity of the latest financial crisis. And given its speed and depth it is reasonable to ask, has the "average" retiree suffered irreparable loss? Perhaps even more pertinent given our compulsory super contribution system for people approaching retirement is, is investing in this market tantamount to throwing good, hard-earned money after bad?
A research paper prepared last month by Vanguard's Investment Counselling & Research Centre in the US has examined four different scenarios in an attempt to give recent retirees some context around the situation they find themselves in.
Importantly the research looked back over the past 138 years because one of the unnerving things about this episode is that there are few historical points of comparison so including a retiree prior to the 1928 sharemarket crash in the US provides important context. Historically US shares have delivered negative returns in 40 of the past 138 years or 29% of the time. Seven of those negative years declined more than 20%. On the other side of course is that 71% of the time investors have enjoyed positive returns.
The worst case scenario for any retiree in these circumstances is if they were 100% invested in equities. Fortunately investor surveys by Vanguard's Investment Counselling & Research Centre in the US show investors aged 65-plus allocate, on average, only 55% of their portfolio to shares.
Three of the scenarios modeled are based on US stockmarket events and one tracks a Japanese retiree. The scenarios track the balance of a $US100,000 portfolio allocated evenly between shares and fixed interest for an investor who retires just before: - The US market crash and great depression of 1929
- The US bear market and inflationary period of 1973-74
- The US bear market of 2000-02 (which includes current market events)
- The market crash and extended bear market in Japan in 1990.
There is no disputing that the retirees would have been better off if their retirement had not coincided with a major market crash. However, despite that painfully obvious fact the research shows that all is not lost for those people unlucky enough to retire at a market's peak.
The hypothetical portfolios assume that retirees spend 4% of the initial balance to supplement pension/social security income. The drawdown amount grows in line with inflation.
The Japanese retiree projects the worst outcome - a direct result of 19 years of poor market performance. The US retiree in 2000 has seen their portfolio decline to about $80,000 by the end of 2008 - so the portfolio has been depleted 20% in just eight years of retirement which is concerning and probably requiring a serious look at spending patterns to slow the portfolio's drawdown.
On the other hand, the research shows that the 1928 retiree, while enduring a significant initial drawdown of 42% over the first three years saw their portfolio grow over time to a value of $153,000 by age 100 (in 1963) despite spending a total of $170,000 from age 66 through to 100. The 1972 retiree fared the best. Despite a two-year drawdown of 24%, their portfolio tripled in value to over $312,000 by age 100 (in 2007) with the high inflation of the 1970s and early 1980s a major factor.
Now in any long-term portfolio modeling like this, small adjustments to the assumptions can have significant impacts. For retirees, the most significant adjustment they can make is to their spending. Simply increasing spending by 1% has a major impact - for example our 1928 retiree would have seen their portfolio value fall to $47,000 by age 100 rather than $153,000.
As retirees, our age is like market performance - beyond our control. But our savings and spending patterns are things we can directly manage.
Any portfolio can be broken down into three major components - contributions, investment returns and costs. A secondary part of this research paper focuses on the importance of sticking to a regular savings or contributions plan. It is this interaction between savings and investment returns that perhaps investors need to pay more attention to.
Thanks to compounding, the more you save the better off you will be even if your particular path results in a market downturn around your anticipated retirement date.
The research shows that while there is a clear impact on portfolio values when retiring just ahead of a major economic or market downturn it need not be catastrophic. By focusing on things investors can control - savings rates, spending, asset allocation, costs and (limiting) market timing investors can improve the long-term prospects of weathering severe market events.
21st-April-2009 | 
