Risk in retirement is often presented as the risk of catastrophe. An advisor recently asked if you would get on a plane if you knew there were a 5% chance of a crash. No? Then why would you accept a 5% chance of failure in retirement?
This framing of risk is fundamentally flawed. Typically, if retirees "fail" to achieve the income they had hoped for, they don't run out of money. They don't experience financial ruin. They adjust — just as they would have during their working years.
Retirement risk is better than the chances that your flight will be delayed or even canceled. Historically, small adjustments would have saved almost any reasonable retirement plan. Downward income adjustments are inconvenient — maybe even painful. But they don't mean financial ruin. You will still reach your destination.
Retirement Isn't a Hedge Fund
Over the past few decades, individual investors have gained access to investment expertise and products that were once the domain only of elite institutions. While this access has mostly been positive, it's important not to be confused by concepts of risk that work well for (some) institutions but are much less useful in planning for retirement.
For example, a highly leveraged hedge fund might fixate on the risk of short-term market losses. If this risk is not well managed, liabilities could emerge in a fast-moving market drawdown that the fund could not meet in the short term, leading to financial collapse.
This is simply not the way liabilities are structured in retirement. Instead, retirees' spending needs tend to come in small packages: Think about monthly utility and insurance bills or trips to the supermarket and the gas station. As long as investors can meet these small, ongoing liabilities with matching small, ongoing cash flows, retirement income is not in jeopardy.
This means that even large market crashes, if followed by recovery, do not impair long-term retirement income.
Since 1928, there have been five rapid U.S. stock market crashes of 30% or more:
- Crash of 1929: -39% (October-November 1929).
- Great Depression: -34% (September-October 1931).
- Crash of 1987: -31% (October 1987).
- Great Recession: -31% (September-October 2008).
- COVID-19 pandemic: -33% (February-March 2020).
The graph below shows how portfolio balances would have developed for hypothetical couples who retired six months before these crashes. These couples followed the well-known (though flawed) "4% Rule" and took $40,000 per year from a portfolio worth $1 million at retirement (all in inflation-adjusted dollars).
