We know the stock market is volatile and we know that stock market losses happen. Traditional advice is that losses can be recouped with time so any investor whose stomach twists into knots when he or she opens a 401(k) statement need not worry if he or she can wait out the correction.
For the most part, there is nothing wrong with this advice, but what happens when one doesn’t have time to wait out the correction?
Systematically tearing apart one’s portfolio is very different from systematically building it up. Losses matter a lot and can become especially problematic if the timing goes against your favor.
We’ve discussed before the vital and uncontrollable role timing plays in retirement good or bad fortune, but I want to point to a different scenario today to further make this long standing and extremely crucial to understand point.
Assuming the same initial $1,000,000 balance and a 4% withdrawal rate we looked at the results for a hypothetical investment using the actual historical rates or return for the Vanguard S&P 500 Index Fund (VFINX) for 1990-1999 and 2000-2009.
Here’s what happened.
1990 to 1999
The first decade was a smashing success. The portfolio ended up nearly four times higher than its starting balance by the end of the decade despite the distributions taken. The calculated annual rate of return comes out to 17.5%. With results like these, its easy to see where the fascination with the stock market comes from.
2000 to 2009
The second decade was far less impressive. Ending portfolio balance was less than half of the starting balance amount and calculated annual rate of return comes out to -1.64%
It’s easy to see how some have become enamored with supposed stock market success. Results from the 80’s and 90’s still influence some to make assumptions about market returns and portfolio results that are likely overstated.
Additionally, and more importantly, distributions from a portfolio are an entirely different consideration with unique analysis regarding rate of return. We’ve shown before how the same average rate of return rolling out in a different sequence can dramatically affect portfolio success or failure.
Since you don’t get to control exactly what time period of market returns will match up with your retirement and you won’t know if the years you got were good or bad until it’s too late, special care needs to be taken with money intended for retirement income unless ample assets or income sources can supplement.
Of course, very few people have suggested an investment strategy that keeps 100% of ones assets in stocks with as broad a risk exposure as the S&P 500. We’ll be rolling out additional analysis on more likely recommended portfolios under similar circumstances in the coming weeks.
Brandon launched the Insurance Pro Blog in July of 2011 as a project to de-mystify the life insurance industry. Brandon was born in Northern New England, and he currently calls VT home. He attended Syracuse University and graduated with a triple major in Economics, Public Administration, and Political Science.