Things Always Look Good… Until They Don’t

What does that mean? It simply means that the best time to consider whether an adjustment needs to be made to something is before it starts to go bad. In the stock market, for example, most people wait until they experience severe losses to make adjustments to the amount of risk, they expose their portfolio too. But imagine if a risk adjustment took place before a dramatic drop in the market. Why not reassess the amount of risk you’re taking while you still have the highest values in your investments. Then you’re taking control before disaster strikes.

Simple math tells the story…

If a $500,000 portfolio drops by 40% in value that is a loss of $200,000, taking the portfolio down to $300,000. Now your portfolio has to earn 67% just to get back to the same $500,000 you had before the severe drop. 67% returns just don’t happen very easily and certainly don’t happen without taking a lot more risk – the very thing you’re avoiding after a 40% drop is more risk.

Now, what if that same $500,000 portfolio drops by 10% in value, that is a loss of $50,000, taking the portfolio down to $450,000. Now your portfolio only has to earn 11% to get you back to your $500,000. It is certainly much easier to earn 11% than it is to earn 67%, and it doesn’t require taking so much risk.

This becomes even more important as we approach retirement, let alone when we are already in retirement. Large drops in an investment portfolio, as we approach retirement, can have a truly devastating effect on one’s lifestyle. It may force someone to delay retirement by a number of years. Or it might require a much lower standard of living during retirement. And how do you measure the amount of stress and anxiety experienced while struggling to recover losses?

And even more devastating, is when these large losses occur during retirement, right when you might be using your long, hard-earned savings to supplement your income. The loss is magnified when someone is depending on the portfolio to supplement their income and the portfolio has a significant setback. Imagine, asking a portfolio for 6% withdrawals, then the 40% drop occurs, and now you’re still taking the same dollar amount from the portfolio, but it now equals a 10% withdrawal rate. Your portfolio may never recover back to its $500,000 in the example above.