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Stocks are booming and the elderly are struggling with long-term unemployment.

Poor job opportunities and a healthy nest egg may seem like a good time to retire.

In fact, it can be a particularly dangerous time for Americans to do so, experts say.

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And new retirees who seek to use a common strategy – the “4% rule” – to raise funds are at risk of running out of money prematurely, they said.

“The 4 percent rule is at greater risk,” Wade Pfau, a professor of retirement income at the American College of Financial Services, said.

Unemployment and stocks

Older workers tend to have a harder time finding work during a recession than younger cohorts.

More than half (54%) of the 1.7 million unemployed workers over the age of 55 are long-term unemployed, according to AARP, a representative group of older Americans. (Economists consider long-term unemployment to be more than six months.)

By comparison, 41% of workers aged 16-54 are long-term unemployed – which is lower but historically still high.

I would be wary of retiring after the market has done this well. The probabilities of continuing are not very good.
David Blanchett
Director of Pension Research, Morningstar Investment Management

The trend for older Americans has occurred, although the unemployment rate for those over 55 has dropped. (In March, it was 4.5%, lower than the 6% national interest rate.)

However, the data suggest that part of the drop is due to retirees choosing to leave the workforce and retire, said Jen Schramm, senior strategic advisor at the AARP Public Policy Institute.

At the same time, the stock market is close to an all-time high.

The S&P 500 stock index has risen almost 50% over the past year. It has risen 10% so far in 2021.

“People tend to retire at the top of the market, not at market declines,” said David Blanchett, director of pension research at Morningstar Investment Management.

Warning time

However, market peaks tend to be the worst times to retire, experts said.

“I would be wary of retiring after the market has done this well,” Blanchett said. “The probabilities of continuing are not very good.”

This is the time when the “sequence of recovery risks” becomes a greater threat.

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Raising money from stocks during the retiring and protracted bear market leaves less runway for portfolio growth as stocks recover. Excessive retirement in the early stages of retirement can weaken a pensioner’s finances in later years.

Therefore, retirement at the top of the market – just before withdrawal – is associated with low safe repatriation rates, said Pfau, who researched the subject.

(In other words, the amount of money retirees can raise from a portfolio with a low risk of running out of money decreases.)

4% rule

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The 4% rule is often cited as a frame of reference for the safe withdrawal of money from pension portfolios.

A measure created by financial adviser William Bengen in the 1990s says that retirees can raise 4% of their total portfolio during the first year of retirement. This amount of the dollar remains the same every year and only increases with annual inflation. This approach has a small risk of running out of money for a 30-year retirement under the rule.

However, the current market environment may mean that 4% is too high a safe withdrawal rate for new retirees, experts say.

This is especially true for those with rigid monthly spending needs, they said. Such individuals do not have much flexibility to cut discretionary purchases (e.g., vacations or eating out) if the market goes sideways.

“If you’re someone who has to have a certain amount, 3% is the new 4%,” Blanchett said of the 4% rule. “Because you don’t have a pillow if things go wrong.”

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However, higher withdrawal rates – 4, 5 or 6 per cent, for example – may be possible if spending can be cut, he said.

The 4% framework also assumes that more than half of the pensioners’ portfolio is in shares, which may not be the case for everyone. It also assumes that spending will not only fluctuate in the cost of living – but flexibility if market conditions deteriorate can improve people’s prospects, experts said.

There are many other factors built into low-risk withdrawal times, said Allan Roth, a certified financial planner at Wealth Logic, located in Colorado Springs, Colorado.

Age, health, life expectancy and the amount of guaranteed monthly income from sources such as social security and pensions (which do not vary according to market conditions) are also important considerations, he said.

For example, a shorter life expectancy and a monthly budget that can be largely covered by social security income are likely to mean that a retiree can withdraw more money from his or her investment portfolio safely each year.

Other concerns

However, stocks are not the only concern in the current environment, experts said.

For example, interest rates are low, which damages the yield on bonds and other fixed income investments.

Some economists have also warned that inflation could accelerate due to the trillion-dollar Covid stimulus money pumped into the economy. If that happens, higher inflation could weaken the purchasing power of retirees and drive officials to raise interest rates, which would reduce bond yields in the short term, experts said.

“Is inflation possible? Yes. But is it clear? No,” Roth said.

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It is also impossible to predict how well the stock market will or will not go in the near future.

Stocks had been the longest 11-year winning streak in modern history before a coronavirus pandemic knocked it to bear market in March 2020. It was followed by the fastest recovery in history.

“I don’t predict a recession,” Pfau said. “But the risk of a recession is certainly greater.”

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