Whenever the stock market experiences fluctuations, a wave of panic often sweeps through the financial media, evoking memories of the 2008 financial crisis and the dot-com bust of 2001. This dramatic narrative is fueled by financial commentators, ranging from cable news analysts to influencers on social platforms, who understand that discussions about potential 50% market crashes captivate audiences. However, this sensationalist approach can lead to increased anxiety, particularly among older Americans and retirees.
For those nearing retirement, there’s a tendency to heavily scrutinize investment portfolios for signs of a downturn reminiscent of 2008. Surprisingly, a detailed analysis by Ben Carlson, a portfolio manager at Ritholtz Wealth Management LLC, challenges the conventional fear surrounding market crashes. In his 2022 report, he revealed that the frequency of severe bear markets is much lower than many anticipate.
Carlson’s research, which examines market data dating back to 1928, indicates that significant market crashes of 30% or more occurred in only about 10% of the years from 1928 to 2021. An even steeper decline of 40% has happened in just 5% of those years. This insight suggests that for a 65-year-old who might expect to live to age 85, the likelihood of witnessing a 40% market drop during retirement is minimal. Furthermore, depending on one’s asset allocation, the financial impact of such a downturn could be mitigated.
For instance, if an individual has allocated only 50% of their investment portfolio to stocks and index funds, a 40% decline in the market would translate to a maximum loss of only 20% in their total nest egg, with the remaining investment possibly secured in fixed income options like bonds and treasuries.
To relieve concerns about potential market upheaval during retirement, Carlson proposes a straightforward formula for investors. The first step is to evaluate one’s personal risk tolerance: how much of your net worth can you reasonably afford to lose without impacting your lifestyle and withdrawal plans significantly? By establishing this threshold, retirees can then divide their risk tolerance by their equity exposure to gauge the market decline needed to hit that personal threshold.
For example, consider a 60-year-old retiree with a portfolio composed of 60% stocks and 40% fixed income. If this individual determines that their risk tolerance caps at 30%, the formula would read as follows: 30% divided by 60% equals an implied stock market decline of 50%. This means that even a significant market drop would need to reach 50% before any lifestyle adjustments become necessary.
While smaller fluctuations in the market may occur more frequently, understanding this personal ratio enables retirees to weather these “storms” without panic. The formula is customizable based on individual preferences and financial circumstances, offering a grounded strategy compared to the often alarmist narratives perpetuated in media.
Ultimately, by focusing on personal risk tolerance and asset allocation strategies, retirees can foster a sense of financial security that allows them to enjoy their retirement years without the cloud of market anxiety looming overhead.
