In this post we explore two of the major external threats to retirement planning: major stock market crashes and the hidden danger of inflation, looking at the historical impact of both over the past thirty years. We also look at the importance of asset allocation in your portfolio and, most importantly, when my birthday is.
Intro
Racial injustice, Coronavirus, forced homeschooling, nonstop election banter, topped with having to watch the NFC East playing football. For many of us getting through 2020 required a heavy dose of a favorite beverage. Did I mention homeschooling? Having two girls, eight and eleven, my go-to was a nice Indian Pale Ale, preferably a Double Nickel IPA or Tröegs Perpetual.
2021 called for a clean start—eating better, exercising more and also consuming less of my favorite beverage. But with Spring now here, the end of the delayed tax season in sight, and Cinco de Mayo approaching (it’s also my birthday if you are looking to send cards), it’s time to focus on beer again. Well, beer and, of course, retirement planning. Unrelated you say? Homer Simpson and I beg to differ.
Let’s start with my ideal yearly spending goal: one 6-pack of beer. Yes, just one. Homer would be proud of the focus but not the quantity. We could extend this to many items or an entire budget and the goal is the same: we need to come up with a retirement plan where there is enough money to cover the cost over the length of the plan.
“Risk-Free” Retirement
The year is 1991, the release year for Smells Like Teen Spirit, Nirvana’s big grunge hit and Homer had only been on television two short years (not counting The Tracey Ullman Show shorts). Let us assume I was 60 years old and just retired from a long career at Mr. Burns’ nuclear power plant. The average cost of my yearly 6-pack is $5.58, but I’ve saved up quite a lot in my 401K: $100.00. Earning the 1991 average 10-year Treasury Bill rate of 7.86%, my nest egg will yield me 41% more ($7.86) than my spending for the year ($5.58) without touching my principal!
With all my savings invested in “risk free” Treasury Bills and my only bill covered, life is good.
Now let’s fast forward twenty years to 2011, the year Prince William married Catherine Middleton at Westminster Abbey and the last year of NASA’s Space Shuttle program.
Tangent alert: From 2011 until 2020 all US Astronauts went to the international space station on Russian shuttles. It was not until the Technoking of Tesla (yes, that is Elon Musk’s official title) developed the SpaceX program and launched the Crew Dragon Demo-2 shuttle on May 30, 2020, that the United States was once again able to enter space without Russian assistance. Say what you will about Elon’s antics, for someone that did not even immigrate to the US until 1995 he has done a lot to shape our country in some extremely positive ways.
Back to 2011: I’m only 80, so I still have quite a few years to go. Sadly, the Treasury rate has dropped to 2.35%, and with inflation my 6-pack is costing me $8.21. Even worse, the 6-pack has been costing me consistently more than my earnings every year since 2001. D’oh! This has caused my principal to drop all the way down to $71.42.
Fast forward to present day, 2021. I’m 90 and entering the year with $0.08 cents in my account. No beer for me this year! What happened to my buffer of 41%? What happened to the “risk free” portfolio?!?!?
Treasury rates went down, but inflation continued its relentless, inevitable march.… The only consolation is that results would have been even worse if I’d kept the funds in a bank savings account.
Now, instead of going “risk free,” what if I had invested the same amount in a plain vanilla S&P 500 mutual fund. Some of you know that three of the worst crashes in US history happened between 1991 and 2021. These included: The Dotcom Bubble Burst (early 2000s), the Global Financial Crisis (2008–2009), and the CoronaCrash (2020). Okay, I made up the name of the last crash but maybe it will gain some traction.
Crash History
Remember Pets.com, Toys.com, and WebVan.com? These were all major stock plays in the late 1990s. The media focus, day-trading (a term invented during this period), and hype around these stocks was every bit as big as GameStop and AMC are today.
When these and other internet stocks cratered, the Dotcom bubble burst, resulting in the longest bear market of the 30-year period reviewed. There were three consecutive years of negative S&P returns in 2000, 2001, and 2002: -9.10%, -11.89%, and -22.10%, respectively. That’s a hard run. It was actually 43 months from peak to bottom, and at the end the decline totaled 34.0%. It took 47 months before the market fully recovered.
Then came the Great Recession from 2007 to 2009 triggered by the subprime mortgage crisis. This “only” took 16 months to reach the market bottom, but the trough was deeper, with a decline from the peak of 49.3%. Similar to the Dotcom Bubble, however, it took 47 months before the market fully recovered.
Finally, fresh in everyone’s mind is the recent CoronaCrash (the name is growing on you right?) this past year. As the world entered lockdown to prevent the spread of the virus, the decline was fast, going from peak to trough in less than 2 months. At the trough the S&P was down more than 37%, but the bounce back was just as quick as the market regained its lost ground in only 5 months.
Gosh, with all those crashes investing in the market sounds bad.
Stock Market Returns
Since we at WJL believe and live index investing, let’s see how my original investment would have looked if I invested the entire $100 balance in equities, specifically the S&P 500 index.
Here are the returns at the three years highlighted earlier.
- 1991 – Retirement: The return was 30.5% or $30.47 earned—plenty to cover my $5.58 in expenses. Ending balance was $124.89.
- 2011 – 80 years old: The return was 2.1% on a balance of $337.95 or $7.13 earned compared to my expense of $8.21. Negative for sure, but the higher balance allowed me to spend some of the principal without worrying. The crash years were much worse than that. Ending balance was $336.88.
- 2021 – 90 years old: Entering the year with a principal balance of $1,066.07! It will take a record decline pretty darn soon for me not to be able to afford my beer. (Please someone knock on wood.)
As you read in the Crash section, it has certainly not been a smooth ride. It’s easy to gloss over this, but I want to highlight one—the 2009-2011 crash.
To get these amazing results you would have had to keep your portfolio 100% invested during THREE CONSECUTIVE years of declining portfolio balances ending with a year that was 22% down! But if you could have held your positions, the end results are striking. Entering 2021 with a portfolio 1,066% more than your starting portfolio is hardly immaterial.
With an expected expense in 2021 of $9.58, I would much prefer to have $1,066.07 in the bank instead of $0.08.
Conclusion
GO 100% EQUITY!!!?
No, that is too simplistic. There are reasons we do not go 100% equity. If you panic during one of these large stock market crashes and the anxiety causes you to liquidate a portion of your portfolio it can put you years behind your original plan. Selling low and then buying high is a plan killer. Think back to the Dotcom Crash. Somewhere during the third year that finished 22% down would you have called up your advisor and had him sell everything or just fired him outright? Nosce te ipsum.
Having a portion of your portfolio in bonds that increase when the market is crashing both lessens the downside and makes you feel better about the position of your portfolio, which is a temporary dumpster fire. This also provides the opportunity for rebalancing. Rebalancing sells the assets while they are at high valuations and purchases other assets while they are low. The very definition of buying low and selling high.
Lastly, if you are still panicking, it may help if you listen to this calming guided meditation from renowned index investor JL Collins.
What do if you are unsure of your risk tolerance? We at WJL can help you run different scenarios for the impact on your portfolio of different allocations, but it is important to realize is that continually increasing your bond allocation does not always make your portfolio safer, it trades one risk for another.
Until next time, spend less than you make, invest the difference in low-cost index funds, be kind to your neighbors, and you will succeed in reaching your financial goals and in making the world around you a happier place.
If you feel you could use some assistance along the way, please feel free to reach out to us.