How Should Pre-Retirees Respond to the Stock Market Selloff?
Ronald Gelok is the President and Founder of Ronald Gelok & Associates, a registered investment advisory firm serving New York, New Jersey and Florida. Ronald is an active member of the Financial Planning Association with over 20 years of financial services experience. He is also a licensed New Jersey attorney and a member of the Elder Law and Real Property, Probate & Trust sections of the New Jersey State Bar Association.
Founded in 1993, RGA has helped thousands of clients achieve their retirement goals. Ronald Gelok & Associates offers a unique five-pillar financial plan that includes tax reduction planning, ongoing portfolio stress-testing, individualised investment coaching, retirement income road mapping, and total estate planning.
Should the stock market’s latest selloff spark concern or prompt investors to make any sudden changes to their portfolios? Why?
It depends. Any market sell-off should prompt you to re-evaluate your portfolio, but not necessarily to make sudden changes. Perhaps re-evaluating your portfolio prompts you to ask the question: “Am I properly allocated, to begin with?”. Step back and take a good look at what you’re doing. Do you have stop-losses in place? Are you properly positioned? Do you have mechanisms in place to prevent large losses?
Rapid declines in the market are always a concern, but if your asset allocation is correct, to begin with, then no, it should not motivate you to make sudden changes. If you’re disproportionality over-weighted in a sector of the market that is historically subject to large losses during a bear market, however, then having a more sensible asset allocation is tantamount. For example, in the last bear market from 30th October 2007 to 5th March 2009, large-cap stocks dropped 57%. And large-cap stocks have led the market upward recently. As a result, many people are disproportionately heavy in large-cap stocks. Let’s say you started 10 years ago with an asset allocation which is consistent with modern portfolio theory; a good blend of stocks and bonds. But each year, perhaps large caps went up at a greater percentage, but you never rebalanced your portfolio. So now, instead of having 40% large-cap stocks in your portfolio, you have 70%. So, if these were to suddenly lose value, as they have before, you are much more vulnerable to loss.
Also, consider a stop-loss mechanism. When you have volatile markets where stocks are trading at unprecedented high price-to-earnings ratios, it’s important to have a part of you that thinks: “What is the most I’m willing to lose as a percentage?”. Whether it’s 10%, 20% or some other number, you need to have a tool in place to stop the losses if the market falls. In other words, you need to have a concrete strategy to limit your downside exposure.
We cannot rule out continued volatility as we have yet to see the full effects of the coronavirus.
Mark Haefele, the Chief Investment Officer of global wealth management at UBS stated: “We view the latest selloff as a bout of profit-taking after a strong run”. What are your thoughts on this?
Yes, this very well may be right. The real question, however, is not whether this is an accurate assessment, but rather if you are exposing yourself to too much downside risk if things start to drop even lower. Ask yourself if you are comfortable with the level of risk you’re currently taking on. If so, stay the course. If not, consider a different kind of diversification for whatever comes next. We cannot rule out continued volatility as we have yet to see the full effects of the coronavirus.
Heightened volatility can be scary for those close to retiring. How should they approach the current market to ensure they don’t experience a loss?
They need to take a close look at and decide what percentage of their money should be protected in vehicles that do not go down when the market goes down. They should consider alternative asset classes that have a protected principal from losses in a down market and that are still able to participate in the upside potential of the market. These types of vehicles allow you to keep market-linked gains in the good years and avoid losses in the down years.
Pre-retirees should also consider incorporating vehicles that offer lifetime income guarantees into their retirement plan. You know that you will need a specific level of income guaranteed, no matter what. Check that you have done the math and do not find yourself with a sizable income gap come retirement. The bottom line is that those approaching retirement should be focusing on finding these unique diversification vehicles to protect their income, regardless of what the market decides to do.
How does diversification across asset classes and regions manage the risks here?
The majority of people in the financial advising business believe in the Modern Portfolio Theory, almost with religious fervour. The idea is that by diversifying into different classes of assets, the overall risk is lowered because historically, as some asset classes go down, others go up.
But the problem with this allocation is that bonds are not performing as they used to. In fact, bond yields are at historic lows. Let’s say you allocate 60% of your portfolio to different classes of stocks and 40% to different classes of fixed income or bonds. Let’s then say that your bond yields don’t even keep up with inflation; worse yet, once you factor in inflation, you may find some of the bond yields are actually nominally negative. I’ve seen this happen first-hand, which shows that classic diversification alone is not the answer in today’s world. I recommend looking at alternative assets that are not directly tied to the market as part of more strategic diversification.
Pre-retirees should also consider incorporating vehicles that offer lifetime income guarantees into their retirement plan.
Is investing in the market a good plan for those structuring their retirement plan?
Despite the risks, there is no doubt that stocks should be a part of your retirement plan. I like quality dividend-paying stocks as part of a retirement plan. I like looking for stocks that the market may be undervaluing. But I strongly believe that not all your money should be in the market. Why?
Think about this scenario. Let’s say you had $1 million invested on 1st January 2000 and you retired with an income need of $50,000/year. Let’s say you were “all in” in the stock market like so many were when the dot.com bubble burst. It had seemed reasonable that a million dollars should be able to produce a 5% return for $50,000/year. But what if your portfolio mirrored major large-cap stock indexes and then dropped 44% in the following 31 months? You would have ended up with a portfolio worth closer to half a million. You’d need a 10% return on investment to keep your $50,000 need for income. And this is not even taking into account inflation or the loss of purchasing power.
Rather than having lost half of their nest egg, that person should have been properly diversified, to begin with. They also should have set up stop-losses to prevent major losses in certain sectors. And finally, they should have incorporated alternate asset classes to ensure their income needs were protected from market fluctuations.
What are the other options at hand for those retiring?
The number one best piece of advice for those about to retire is: be certain you are working with the right adviser. Only work with an adviser who is bound by a fiduciary duty to act in your best interest. Typically, independent registered investment advisory firms are legally obligated to do this. Conversely, an adviser who does not have this fiduciary duty is often more likely to be working for their employer’s best interest.
The second piece of advice I’d add is: be sure to factor the inevitability of rising taxes into your plan. This is especially essential since the government borrowed trillions of dollars to fight the coronavirus pandemic. Rarely do we see retirement planning that actually incorporates strategies to reduce tax liabilities. Most retirement plans act like the current historically low tax rates will be the same for the next 30 years. In fact, it’s been my observation that less that one in ten advisers do any kind of advanced tax-reduction planning. So be sure you are working with someone who has the proper licenses and know-how to effectively plan for this.
Lastly, in my experience, your financial life and future can be more complex than you think. Make sure you get yourself a financial plan that includes the five most important areas of a financial plan: tax reduction planning, ongoing portfolio stress-testing, individualised investment coaching, retirement income road mapping, and total estate planning. At my firm, Ronald Gelok & Associates, we call this the five-pillar financial plan. It works because, like every reliable plan, it leaves nothing to chance.