If you have sold out of the market during this extreme downturn, that most likely means you have taken a loss. It may also mean you are no longer in the market to participate in the recovery, once the markets have reached the bottom. And, if you are still in the market, you have seen a decline in the value of your portfolio. As I have stated before, this financial crisis has left few safe areas to turn.
For retirees taking income, selling out of the market at these low levels or dealing with a portfolio that is significantly smaller than the values at the beginning of the year can create major problems. These problems may materialize within weeks or months, or they may not show up for years. The problem is the ability to produce the income you need for the rest of your life. If at the start of the year the expected annual withdrawals from the portfolio were five percent (5%), today the same withdrawals may translate into a 6.25% to 7.7% withdrawal rate. These withdrawal rates may be sustainable, especially if a recovery in the portfolio value occurs sooner rather than later. Other steps may also be taken to help insure the withdrawal income is sustainable. The problem arises for those retirees already taking an 8% withdrawal rate at the beginning of the year. For them, the withdrawal rate may now be as high as 12.3%.
I do not believe it requires a study to understand a withdrawal rate above 10% may eventually undermine the value of the portfolio. The likelihood the portfolio will pay out more than it makes is very high; and in a second down year, the overall decline in value can be substantial and perhaps irreversible.
To avoid depleting your portfolio and thus running out of income, additional steps need to be taken. First, each retiree taking income from their investments must determine if the amount they are taking is really required, or if they can temporarily reduce the income. If the withdrawals can be reduced or stopped all together for a while, then this action should be taken. If the income is truly as low as possible, then a review should be taken to determine if the income can come from other sources. Instead of selling funds at low values, there may be other assets which were not in the market or were affected less, and thus these can temporarily provide the better source of income.
Here is an example of why it is problematic of selling when the price is low. If shares of a stock fund were being sold to create monthly income, while the price per share was $40, only 25 shares had to be sold to produce $1,000 distribution. However, after a 30% decline in value, the fund now trades at $28 per share and to produce the same $1,000 distribution almost 36 shares have to be sold. This means 44% more shares are now required to be sold to produce the same income. Once the higher number of shares has been sold for a few months or longer, a greater number of shares were sold out of the account to produce the same income thus leaving fewer shares to recover the portfolio's value.
If you are scared and have been managing the investments on your own, it may be time to find a professional to assist you during the next few years. The professional should be in my opinion a CERTIFIED FINANCIAL PLANNER®. It would be best they personally have fifteen or more years of experience or are working closely with a partner meeting this level of experience. The professional should also have a substantial client base that is your age or older. This way you have a better chance of working with a professional who is focused on many of the items important to you.
Last week, Warren Buffett contributed an article to the New York Times about investing and the current financial crisis. Mr. Buffett shared a personal rule about investing, "Be fearful when others are greedy, and be greedy when others are fearful." Clearly, fear is widespread, and thus this may be time to be making strategic purchases. He also made another point which may be one of the reasons for his tremendous success, "I can't predict the short-term movements of the stock market. I haven't the faintest idea as to whether stocks will be higher or lower in a month - or a year from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either the sentiment or the economy turns up. So if you wait for the robins, spring will be over."
As I said in my title, it is okay to invest once the markets have reached the bottom. So please read my column during the next six months or so. And once I am sure, I will share with you when the bottom occurred. The problem though, most likely I will be pointing to a time two or three months back, and the markets may have already made a substantial move up. Managing investments is not a hobby; and something as important as the financial security during retirement years, a professional needs to be on the team.
HOW TO REACH THE WRITER
Would you like a response to a financial question? Send your question to Doug Horn, 115 W. Broadway, Maryville, TN 37801. Be sure to mark your envelope Money Matters.
Doug Horn, CFP, is an area financial planner with more than 24 years financial experience and founder of Quality Financial Concepts, located in downtown Maryville on Broadway.
Doug Horn, CFP, Registered Investment Advisor in Tennessee and Texas and Registered Principal, Branch Office of and Securities offered through CUE Financial, Member FINRA, SIPC.