One thing tends to hold true with both injuries and investments: The older we get, the harder the recovery
It’s no secret that as we age it takes more time for us to recover from injuries. Those sprained ankles or strained backs that used to heal in a few days when you’re 20 might take a few months when you’re 60. We recover more slowly with age, plain and simple. Interestingly enough, the same could be said for our investments. Why might that be? A big part of it is Contributing vs. Distributing.
While we are working age and earning an income, many of us are systematically deferring a percentage of our income into a retirement account on a bi-weekly or monthly basis. Not only is this an excellent way to systematically set yourself up for the future, it can also help you take advantage of market downturns in the meantime by purchasing into the market at lower prices. I would argue that downturns during our working years can be welcome opportunities to those who are systematically investing.
On the contrary, if you’re retired and drawing income from your assets systematically, there’s no bright-side to a downturn. Unlike the working years when you’re buying low during a downturn, if you’re living off of the assets, a downturn could force you to sell low. This means putting your portfolio in a position where it’s more difficult to recover. Not only does the account need to recover the amount it’s lost due to market action, it’s also got to earn enough to replace the distributions you’ve taken. Yikes.
Let me give an example that might make the concept easier to visualize. Let’s use the Great Recession stock market decline that began in late 2007 and bottomed in early 2009 as our time-frame and imagine we have 2 individuals:
As of July 1, 2007:
Joe Standard is 35, has $100,000 in his IRA and is CONTRIBUTING $400 per month.
Mary Poors is 65, has $100,000 in the same mix of investments in her IRA and is DISTRIBUTING $400 per month for living expenses.
Because Joe Standard is contributing $400 per month when the market is down, he gets to purchase investments at a lower price. He’s adding to his account and buying cheaper shares, which allows his account to recover to $100,000 in just 3 years. 6 years later, his account has earned an average growth rate of 4.5% and his account is now worth $163,000! The shares he was able to purchase while the market was down have produced higher returns for his portfolio and boosted his average return. Joe, being younger, bounced back relatively swiftly.
Mary, however, has had a much different experience. Mary’s account has yet to recover 6 years later. In fact, she’s still only at $81,000. Her average return during this period? 1.8%. Less than half of Joe Standards return. Those shares Joe was buying cheap, those were Mary’s shares she was forced to sell at lower prices, locking in losses and significantly lowering her average return on the overall portfolio. Mary Poors won’t see her account's value recover past $100,000 until 2015, 8 years later. By then, Joe’s account would be worth double that.
So how might you avoid Mary’s situation? Similar to the ways we protect our bodies as we get older by stretching, wearing a knee brace, or avoiding activities that make us susceptible to injury. We can take some precautions and avoid unnecessary risks. As you enter retirement, I believe you should have a strategy and a plan in place with your investments to help manage risk during periods of volatility. Consider a Multi-Bucket Strategy, which I highlighted in an earlier blog post that I encourage you to read.
Injuries, like downturns, are an inevitable part of life. Do your best to take preventative measures and mitigate the severity so your recovery is less daunting.
This is meant for educational purposes only. It should not be considered investment advice, nor does it constitute a recommendation to take a particular course of action. Please consult with a financial professional regarding your personal situation prior to making any financial related decisions. Indexes are unmanaged and cannot be directly invested into. Past performance is no guarantee of future results. Investing involves risk, including the potential for loss of principal. 10/18