By Wei Hu, Vice President, Financial Research, Financial Engines
If you’re worried about how the recent stock market declines might affect your retirement investment strategy, we’d like to provide some perspective that may ease your mind a bit.
A 20 percent decline in the stock market doesn’t automatically mean a 20 percent decline in your portfolio.
If we’re managing your retirement account, your investment portfolio has a diversified mix of bonds, as well as U.S. and international stocks. The news headlines tend to focus on just the Dow or the S&P 500 indexes, which only tell you how large-cap U.S. stocks have performed. Those indexes don’t give a complete picture of how the entire U.S. stock market has performed, and they don’t reflect foreign investment performance at all. While the S&P 500 has declined by 21 percent this year (as of March 27, 2020), bond investments have been flat or slightly positive. As of March 27, 2020, the Barclays Aggregate Bond Index is actually up 2.7 percent.
Let’s look at a couple of simplified examples that show how the recent market performance could translate into the performance of a retirement investment portfolio.
If you have 10 years until retirement, a typical recommended investment mix would be 30 percent bonds and 70 percent stocks. Let’s assume this allocation consists of the Barclays index (bonds) and the S&P 500 index (stocks). This portfolio would have fallen by 14 percent so far in 2020. Certainly not ideal, but not nearly as bad as the decline in the stock market you see in the headlines.
If you’re close to retirement, our typical recommended investment mix would be even less risky — more like 45 percent bonds and 55 percent stocks. Again, assuming the Barclays and S&P 500 indexes as the investments, this portfolio would have seen a loss of about 10 percent so far in 2020.
A 10-14 percent temporary drop in your retirement account balance doesn’t automatically translate into a 10-14 percent drop in your projected retirement income.
Your projected retirement income will come from several sources:
- Current retirement account balances.
- Growth of current balances.
- Future retirement account contributions.
- Growth of future contributions.
- Social Security and pensions.
Only the first two are affected by what’s happened in the market. Your balance may have fallen 10-14 percent, and any potential growth will start compounding from this lower balance. But your future savings contributions should stay the same. Our projected future returns on those contributions are basically unchanged because they are based on expected long-term market performance. Of course, the value of your Social Security benefits and any pensions you may be entitled to aren’t affected by the stock market.
How much those first two components affect your retirement income depends on your situation. They’ll account for more of your retirement income — about 60 percent — if you are within 10 years of retirement, have a large retirement account balance or higher earned income, or if you are making lower retirement plan contributions. They’ll be a smaller portion — about 40 percent — if you are many years away from retirement, have lower income or savings balances, or are saving more.
Putting it all together
The takeaway here is that the effect of stock market declines on your retirement savings strategy can be lessened by having a diversified portfolio along with your other sources of retirement income.
Going back to the 10-years-from-retirement example above that saw a 14 percent drop in the retirement portfolio value (the portfolio is responsible for 60 percent of future retirement income), the actual reduction in projected retirement income is just 8 percent (14% x 60% = 8%). That’s not happy news, but it’s hardly catastrophic for someone who still has 10 years to make adjustments.
We’re just showing you how a retirement account — and future retirement income — does not necessarily run in lockstep with overall market performance. Your individual results may be different. We encourage you to visit our site or call an advisor representative to learn how recent market performance may affect your retirement strategy.