A man watches plummeting stock indexes on the Nasdaq MarketSite on December 20, 2000, in New York’s Times Square.
Chris Hondros | Hulton Archives | Getty Images
While baby boomers hog most of the attention in conversations about retirementmembers of Generation X are marching towards the same destination and, in many cases, without the essential financial advantages of the previous generation. Retiring at 55 in America is essentially a relic of the past funded by defined benefit pension plans. Today, most people aged 50 to 55 still see 10 to 15 years of work ahead of them. This extends the years during which they continue to contribute to 401(k) plans and IRA to increase their wealth, and time spent in the market is the the greatest long-term benefit investors did. But the closer an individual gets to retirement, the more an inopportune event stock market crash can seriously set them back.
Generation Only 14% of Generation X workers have a traditional pension, compared to 56% of baby boomers, according to a study by Alliance’s Retirement Income Institute. Broken down by generation, Generation X is the least financially prepared generation for retirement by almost any measure. “While baby boomers dominate the headlines, Generation X faces an even more serious retirement crisis,” the authors write.
The situation may cause a Gen Xer to watch their retirement fund warily. A decade of high returns has placed many investors, particularly those within a few years of retirement, heavily weighted in S&P500 mutual funds and ETFs, surfing on record stock market gains until retirement. But history is littered with accidents that, for the unlucky, come at the worst possible time.
The Amazon dotcom bubble stock chart is a good example. Investors who bought at its peak in 1999 had to wait a full decade before the stock regained that old high, finally hitting new record highs in late 2009. The broader S&P 500 index shows a similar finding. story of a slow road to recovery. After hitting its lowest level in October 2002 following the collapse of the Internet sector, the index took nearly five years to climb back to a new high in 2007 – a peak that didn’t even hold, as the Great Recession wiped it out almost immediately. From the low point of this second crash, in March 2009, it took another four years before the S&P 500 finally crossed its old peak of 2007, in March 2013.
Depending on how you count it, that’s between four and thirteen years underwater, depending on the accident and the depth from which you measure. And for someone three or five years from retirement, this is not an academic deadline.
Certified financial planner Ernie Cave, founder of Cave Wealth Management, says what goes down will eventually go up, but when it matters for retirees. “History shows that markets recover, but retirees can’t choose whether that recovery takes a year or several. If you’re forced to sell investments while they’re depressed to generate income, those stocks disappear forever and can no longer participate in the recovery,” Cave said. This is why what financial advisors call “sequence of returns” risk is so dangerous.
How to gradually move away from the S&P 500For starters, investors already thinking about retirement should avoid being hit by the S&P 500’s gains and the positive results it has brought them.
“One of the biggest mistakes I see is investors approaching retirement with almost all of their assets in an S&P 500 fund simply because it has performed well over the past decade,” Cave said. The S&P 500 is a great long-term investment, but it may not be the right place to find the money you’ll need during the early years of your retirement, he added.
“The problem is not owning an S&P 500 fund. The problem is asking the same fund to pay next year’s bills and fund retirement in 25 years,” Cave said.
He recommends directing retirees towards a diversified “war chest”.
“We generally want about two years of expected portfolio distributions to be protected in cash or very short term investmentswith approximately five years of planned withdrawals covered by cash, Treasuries, CDs, and high-quality bonds. The remaining long-term assets can remain invested for growth,” Cave said.
According to Cave, the goal of a retirement war chest isn’t to get rid of stocks or eliminate market declines. “This is to reduce the risk that a retiree will be forced to sell long-term investments during their tenure,” he said.
Learn more about the ETF Strategist:Investors nearing retirement don’t necessarily need significantly less exposure to stocks, but they do need a clearer separation between money they’ll soon be spending and money that can stay invested throughout the next market cycle. “Retirement doesn’t eliminate the need for growth. It changes the dollars one can afford to wait,” Cave said.
Some Gen Xers are on the path to retirement – literally – and this has hopefully limited their exposure to market volatility. A transition path is the gradual shift from a stock portfolio to bonds as an investor approaches and moves through retirement, thereby reducing exposure to a market downturn when it would hurt them the most.
“A gradual trajectory gradually changes the portfolio as a client gets closer to retirement,” said Elias Friedman, CFP and founder of Kadima Wealth.
Build a temporary link tentAnother shield against a market crash is bond tenting, a strategy of temporarily increasing bond holdings in the years before and after retirement – the riskiest period for a market downturn.
“Both options can reduce the risk of having to sell stocks after a significant stock market decline. In my experience, clients are more accustomed to a step-by-step investment approach,” Friedman said.
Unwinding a bond tent isn’t about waiting for a signal that the danger has passed, Friedman said — no one can reliably call that moment, and trying to do so is really just market timing by another name.
“The client has many options for how to manage this risk. For example, consider a ladder of bonds or CDs or short- or intermediate-maturity securities. You don’t have to put all your money back into the market at once,” Friedman said. “Smart clients will proceed tactically by occasionally rebalancing their portfolio. This will help mitigate some risks.”
Regardless of the path forward, Friedman says any transition should be gradual rather than making a big change in reassignment upon retirement. “Think of it like taking a cross-country trip on the highway and then slamming on the brakes. I’ve found that slowing down gradually makes driving less stressful and more comfortable,” he said.
But this market is different from previous ones in at least one important way, says Asher Rogovy, chief investment officer at Magnifina, a registered investment advisor: AI and the growing importance of a handful of technology stocks in the S&P 500.
“Traditionally, 20 to 30 individual stocks provided sufficient protection against company-specific risks. Today, an estimated 40 to 50 percent of the S&P 500’s market value is in companies tied to a single theme: AI,” Rogovy said.
If past is only prologue, that could mean this won’t end well, Rogovy said. “We’ve seen this story before. The dot-com bubble involved similar levels of index concentration, and the consequences should give us pause,” he said. “Concentration risk is inherent in cap-weighted indexes. In particular, investing an equal amount in each S&P 500 company would have avoided much of the decline and reached new highs years earlier,” Rogovy said. The S&P created an equal-weighted version of the index in 2003, and there are now many funds and ETFs that offer the ability to have core exposure to the equal-weighted S&P 500.
But Rogovy doesn’t think there’s a purely stock market strategy that can completely escape a stock market crash. So he says the most important decision for anyone approaching retirement is the allocation between stocks and bonds. “Since most people are much more familiar with stocks than bonds, this is where an investment advisor can be invaluable. By combining a bond allocation with disciplined rebalancing and value investing, an advisor can build a portfolio that can withstand volatility to protect a client’s retirement,” he said.
For a Gen Xer right now, the biggest danger is the concentration of companies in an S&P 500 fund, said Mike Dunlop, CFP and co-founder of Ignite Planning in Cedar Falls, Iowa. “Right now, seven of them make up more than 30 percent of the total. For someone aged 50 to 55, the real danger is not an accident, it’s an accident at the wrong time – or risk of streak of returns,” Dunlop said.
“If the market drops 30% the year you retire and you withdraw money to live on that year, you sell at the bottom to buy your groceries and gas, and that share never has a chance to recover,” he said. “A retired loved one doesn’t have a wasted decade to give up,” he added.
His fee-based financial planning firm moved some of its clients’ assets out of the core S&P 500 or broad stock index funds and reallocated them into large-cap value companies — “the same stock market, but without betting the entire retirement on the seven biggest names,” Dunlop said.