Did you know that of those who die on Mount Everest, 80% died not on the way up, but on the way down? They had so diligently planned and trained for how to climb the summit that they didn’t plan nearly as much for the dangers of getting down. Reasons for failure include lack of fitness and strength, lack of oxygen and issues with weather and traffic on the mountain.
I’m using this metaphor to describe how people plan for retirement. They spend all their working years planning and accumulating, so they can have the most amount of money and get to the top, but when they are finally in retirement, most people have no plan for how to distribute assets to provide a dependable income stream.
I’d correlate the lack of fitness, strength, oxygen, weather and traffic on the mountain to financial factors such as market volatility, how long we may live in retirement and taxation. All these issues need to be identified and planned for, or you’ll have major issues coming down the mountain — providing a dependable retirement income.
Stock market volatility, your longevity and taxes are the three risks you need to prepare for as you near retirement. Let’s consider each of them:
Preparing for stock market volatility
Since 1900, the stock market has done really well over the long haul. However, if you break it up into five-to-10-year segments, there has actually been some pretty serious volatility (not to mention the awful, wild swings we’ve seen lately). To understand how to prepare for stock market volatility as you retire, it may help by answering two key questions:
What does volatility mean to my retirement?
For the sake of argument, let’s imagine we’re sitting in a bull market and you’re retiring in five years. History has shown, however, that a bear market — a sustained loss to the stock market — will come. That’s why when we retire can be as important, or more important, than how much we actually save for retirement.
Focusing on strategies that avoid those bear market times is the first step in dealing with volatility; smooth out the volatility so you don’t experience those large losses.
What happens if I invest in the stock market and it tanks?
Let’s say you were to invest $100,000 into the stock market. The first year you lost 30%. How much do you think you need to earn the following year to get back to your original $100,000 or break even? Isn’t it the same 30%?
Nope. It’s 42%. The reason is because you’re earning income on less money.
In this example, you only had $70,000 in that second year to invest rather than $100,000, so you need to earn 42% rather than 30% to get back to your original amount.
The moral: try to invest more than you think you need to, and diversify well among stocks...