The American Funds has an article in their recent “Investor” magazine about retirees who encountered financial setbacks in the last decade. What they did can be instructive to people who retired some time ago and those who have yet to retire. From the article:
You’ve spent a lifetime contributing regularly to your 401(k) plan and watching your expenses carefully. You followed the lessons of sound personal ﬁnance and maintained a diversiﬁed portfolio. Can you still be surprised later by costly retirement expenses you didn’t foresee?
The answer is yes, say ﬁnancial advisers. “I was naive when I retired 10 years ago,” admits a 70-year-old from California. “There are a lot of hidden costs in retirement that people don’t recognize. I call them stealth expenses.”
These costly retirement surprises range from higher medical costs and signiﬁcant taxes on retirement income withdrawals to a decade distinguished by historic market volatility. We spoke with several American Funds investors to learn how they dealt with unexpected retirement expenses.
Extreme market volatility
Ten years ago, Phil Reynolds of Clarklake, Michigan, a former machine tool service representative, could see the writing on the wall: Lower cost foreign competition had taken away much of the U.S. machine tool business, and the American auto industry was facing a difﬁcult period of lower sales. After consulting with his ﬁnancial adviser of more than 30 years, Phil decided to retire early at age 55. Phil, who’d been investing in mutual funds since 1980 and had a well diversiﬁed portfolio of stock and bond funds, felt he was prepared for future market ﬂuctuations. At the time, the stock market was still reeling from the dot-com debacle, which then was considered the
worst decline in three decades. But that didn’t deter Phil from retiring. He and his wife, Linda, maintained a long-term perspective. Within a few years the market had recovered — and by 2007 it had reached new highs. “The fact that we’d survived the 2001 downturn with our retirement savings intact gave us more conﬁdence,” Phil says.
Little did they know just how badly that conﬁdence would be shaken. In late 2007, the housing bubble resulted in a financial crisis that caused equity markets to plummet 55% (based on the unmanaged Standard & Poor’s 500 Composite Index with dividends reinvested) between the market peak on October 9, 2007, and the market low on March 9, 2009. This time Phil panicked. “I was scared to death,” he recalls. “I told my ﬁnancial adviser that I wanted to get out entirely because I didn’t know when the market would hit bottom.”
His adviser encouraged him to stay the course. “I sweated that one out,” Phil admits, “but in the end I followed his advice.” When things got tough, Phil trimmed his annual retirement income withdrawal rate from almost 5% to 3%. He and Linda had already taken the precaution of maintaining a large emergency fund, which enabled them to avoid selling shares of their mutual funds when the market was down.
By the end of June 2012, the couple’s portfolio had recovered to a point where it was close to what it had been at the October 2007 market peak. They were helped by the fact that their investment portfolio contained a mix of growth-and income funds, balanced funds and bond funds. “Our investment strategy was fairly straightforward,” Phil adds. “We weren’t worried about hitting home runs. All we wanted to do was get on base and maybe hit a double once in a while. That helped us a lot.”
There are lots of people like the Reynolds. The advice they were given was good, their strategy was sound. Reducing spending when portfolios decline allows the rebound to rebuild lost ground faster. Having an emergency fund is a great help in times of volatility not just because it keeps you from selling at the wrong time, but acts a a security blanket, making it psychologically easier to weather financial storms. Often the best advice a financial adviser can give his clients is to stay the course.