Well, we had a good run. From 2009 to early 2022 making money in the stock market was like shooting fish in a barrel. Low valuations coming out of the great recession of 2009 and rapid economic growth made for a great bull market. Then, the Fed’s covid-induced, easy-money stimulus policy in 2020 added fuel to a roaring bull-market fire.
In the back of your mind, you knew the good times wouldn’t last forever. They never do. But did you expect this bull market would turn on a dime? The steady, multi-year upward move in stocks has given way to violent daily swings as investors debate how high interest rates will rise, whether 40-year high inflation will abate, and whether the economy will be tipped into a recession.
The market has already declined 17% this year. What if it falls another 10% this year and 20% next year? How long can your retirement funds last in the face of a two-year bear market? You’d better find out now because you may need to make adjustments before it’s too late. The Relax Retirement planner can “stress-test” your nest egg to ensure your retirement will not be derailed by a bear market.
Nowhere to run to, nowhere to hide
Up 380, down 650, up 923, down 477, and up 290 – describes a typical week for the Dow Jones Industrial average these days. In the old days (not that long ago), the market perhaps moved 2%-3% in a couple of months. Now it moves that much one day, then moves just as much in the opposite direction the next day.
What’s going on? The increased volatility is due to several things, including:
Inflation has skyrocketed to levels not seen since the 1970s due to covid-related easy money stimulus policies and supply-chain bottlenecks, and the Ukraine war.
In response to higher inflation, the Fed has begun aggressively raising interest rates, reversing a 40+ year downward trend. More hikes are expected.
Higher rates have sparked a re-rating (downward) of the P/E multiple the market is willing to pay for all stocks, particularly money-losing, high-growth stocks. The market’s multiple based on estimated 2022 earnings has declined from about 22 to roughly 17-18, resulting in a 17% year-to-date decline in the S&P500.
Higher interest rates could slow the economy and possibly cause a recession, which could hurt corporate profits and lead to further market weakness.
Rising interest rates hurt fixed-income (bond) prices and falling P/E multiples hurt stocks. Today’s investing environment can be summed up by a line from Martha and the Vandellas’ song: “Nowhere to run to baby, nowhere to hide.”
So what’s an investor to do? Since no one can predict the future, we suggest “stress testing” your retirement nest egg to determine if it can withstand a worst-case scenario, such as persistently high inflation and a prolonged bear market. Be sure to do this before a recession or bear market so you’ll have time to make adjustments if necessary.
Use the Relax Retirement Planner to stress test your retirement funds
Here are the steps necessary to determine a “worst case” scenario using the Relax Retirement Planner:
1. Update all investment balances to reflect the recent market decline
2. Recheck the accuracy of your annual expenses estimate
3. Enter an inflation rate of 5%-6% for 2 years, then 3%-4% thereafter
4. Enter 5%-7% for an equity return and 3%-4% for a fixed income return
5. Model two or three consecutive annual declines in the stock and bond markets:
Enter a 5%-8% market decline at your current age (this equates to a 20%-25% total decline in 2022). Do this for equity and fixed income in all asset categories.
Enter a 10%-20% market decline for 2023 for both equity and fixed income in all asset categories. This will model a two-year sequential market decline, which has occurred four times since 1928.
For an ultra-conservative estimate, enter a third straight market decline of 10% for 2024. Three-year sequential declines have occurred three times since 1928.
Enter an “interval” market decline of 10% every 5 years starting 7 years from now (start 8 years from now if you implemented a 3-year sequential market decline) for both equity and fixed income in all asset categories.
6. If married, factor in the death of a spouse to model the impact of the loss of one income.
If your savings lasts beyond your/spouse expected lifetime (plus a few years of cushion) using these conservative assumptions, congratulations! Be sure to run a couple of Monte Carlo simulations to get a second opinion. If your nest egg does not last beyond your expected lifetime, start making contingency plans.
Follow the boy scout motto
The good old days of this bull market may be over, but there’s no need to be afraid of the future. Just follow the Boy Scout motto: Be Prepared. And the only way to prepare is to know your potential downside before it’s too late to make adjustments.