One of the biggest frustrations for investors is that there is one huge factor no one can control—the returns that the financial markets are going to provide in any given stretch of time.
When we first start investing, we probably ought to receive the serenity prayer* along with the prospectus for whatever fund or security we’re purchasing.
It goes against the grain for most of us to, as the prayer says, “accept the things I cannot change.” So it can be tempting to try—or pay someone else to try—to gain control by timing the markets. The temptation is never stronger than at times like now—after all, 2008 was the second-worst year for stocks in the past century. “If only,” the hope goes, “I could get out of the stock market before it nosedives, then get back in when the coast is clear.” Alas, evidence of effective timing schemes is pretty scarce.
But while we can’t control that one big factor—the markets—we’re not entirely in the hands of the fates. In a short video on managing retirement savings during a bear market, Fran Kinniry, a principal and investment strategist here at Vanguard, focuses on factors we can control as we are near or in retirement.
Fran has looked at past bear markets to demonstrate how the damage they do to retirement portfolios can be significantly lessened by the application of “levers” that we can control or significantly influence:
• Whether we have (and stick with) an asset-allocation plan (with periodic rebalancing).
• The rate at which we save for retirement.
• The rate at which we spend during retirement.
• The investment costs we incur (fund expense ratios, commissions, and taxes).
He doesn’t sugarcoat the current bear market. Fran notes that even for a balanced portfolio, 2008 was one of the worst years on record. The silver lining in this admittedly dark cloud is that simulations based on four past severe bear markets found that even investors who retired just before those bear markets began would have been able to sustain a reasonable withdrawal rate (4% of the initial portfolio balance, with ongoing withdrawals adjusted up or down for inflation or deflation) for 20 years or more, if they continued to stick to a balanced broadly diversified investment plan and kept their costs low.
The simulations assumed retirement started on Dec. 31 in 1928, 1972, or 1999 for U.S. investors or on December 31, 1989, for Japanese investors. What ensued in each case was a bear market that saw broad stock market indexes fall by 50% or more. To simplify the illustration, Fran’s scenarios used returns from just two asset classes—broad domestic stock market indexes and broad bond market indexes—and didn’t include alternative asset classes such as Treasury securities, real estate, commodities, etc. (More on the data sources he used can be found in notes on the hypothetical scenarios at the bottom of this post.)
It’s important to note that the projections that Fran worked up are hypothetical and don’t represent the actual investment results any given individual experienced, and they certainly aren’t a guarantee of future results for investors. However, it seems fair to say they do highlight the importance of balance and diversification, of keeping withdrawals from retirement savings at modest levels to allow for market fluctuations, and to focus on costs. These are, after all, the things most under the control of the investor.
Of course, given that we’re human beings, it is easier said than done to stick with an investment plan as markets gyrate. In up stock markets, for example, it can be really hard to maintain your asset allocation by rebalancing some money out of stocks and into bonds. And at times like these, when you might have to move money from bonds into stocks to keep your asset allocation on target, it’s really difficult to stick to plan.
Of the levers within our grasp, the hardest to control may be our own investment behavior.
* “God grant me the serenity to accept the things I cannot change; courage to change the things I can; and wisdom to know the difference.”
IMPORTANT: The projections regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. The calculations for Fran Kinniry’s hypothetical scenarios assumed the following:
• A mix of 50% domestic stocks and 50% domestic bonds (nominal, not inflation-adjusted bonds) is maintained in retirement.
• 4% of the portfolio (adjusted for inflation annually) is withdrawn for spending purposes on the first day of each year.
• All values are shown in 2009 U.S. dollars; and Japan’s performance is denominated in yen.
Sources for return data were chosen to represent broad asset classes. The inflation data are official figures from U.S. and Japanese government agencies.
U.S. equity market returns: From 1871 through 1925, data provided by Wilson and Jones (2002); from 1926 through 1970, the S&P 500 Index; from 1971 through 2005, the Dow Jones Wilshire 5000 Index; thereafter, the MSCI US Broad Market Index.
U.S. bond market returns: From 1871 through 1925, total return data for U.S. Treasury bonds provided by Global Financial Data; from 1926 through 1968, the S&P High Grade Corporate Index; from 1969 through 1972, the Citigroup High Grade Index; from 1973 through 1975, the Barclays Capital U.S. Long Credit Aa Bond Index; thereafter, the Barclays Capital U.S. Aggregate Bond Index.
U.S. cash returns: Since 1926, data from the Citigroup 3-Month Treasury Bill Index.
U.S. inflation statistics: From 1871 through 1912, we used estimated inflation provided by the Federal Reserve Bank of Minneapolis (Consumer Price Index [Estimate], 1800–2005); thereafter, we used the consumer price index (CPI) provided by the Bureau of Labor Statistics, U.S. Department of Labor.
Japanese equity returns: From 1951 through 1969, data from the Nikkei 225 Index (in yen) via Thompson Datastream; thereafter, the MSCI Japan Index (in yen) via Thompson Datastream.
Japanese bond returns: From 1951 through 1965, the discount rate of commercial bills (converted to total returns) provided by the Bank of Japan; from 1966 through 1984, the 10-year constant maturity bond (converted to total returns) provided by the Bank of Japan; from 1985 through 2000, the Citigroup World Government Bond Index—Japan Index (in yen) via Thompson Datastream; thereafter, the Barclays Capital Japan Aggregate Index (in yen).
Japanese cash returns: From 1951 through 1985, the National Discount Rate provided by the Bank of Japan; thereafter, the JP Morgan Japan 3-Month Cash Index via Thompson Datastream.
Japanese inflation statistics: From 1951 through 1955, CPI numbers from the Japan Ministry of Internal Affairs and Communications: Statistics Bureau; thereafter, CPI numbers from the Bank of Japan via Thompson Datastream.
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