In a previous blog post, What Impact Will the Covid-19 Crisis Have on Investors, we began to answer the question by separating investors by their life stage – accumulators, pre-retirees, and retirees. Depending on which stage investors are in, the crisis will impact them differently. As we concluded in that post, accumulators who are at least ten years from retirement, and who are patient and disciplined, should benefit from any COVID-related downturns right now. Current retirees who rely on their portfolios for income are the most impacted, and we’ll look at that further in our next post. Pre-retirees, the group we’re discussing in this post, could be impacted but with no need to panic. Here’s why:
Making Adjustments to Stay on Course
The focus of pre-retirees who are on the glide path to their retirement is how they are going to replace their paycheck and make their final approach adjustments to ensure they hit their target. It’s the most complicated stage of retirement planning because it’s about transitioning from capital accumulation to income distribution in a way that can create lifetime income sufficiency. Planning in this stage is never a set-it-and-forget-it proposition. It requires adjustments to be made along the way.
It’s not unlike a plane that takes off from Los Angeles to fly to Hawaii. Most passengers might be shocked to learn that, when pilots take off, they are off course 98 percent of the time, but somehow they always manage to land in the right place. It is the constant monitoring of their position and all of the variables – i.e., wind speed, airspeed, fuel burn, etc. – enabling pilots to triangulate to their destination.
For pre-retirees, a moment like this requires a complete review of their assumptions and other factors to plot their course. That could include their assumptions about timeframe, lifestyle costs, and investment returns. It should also consist of a reassessment of income sources, including portfolio returns, interest, pension payments, and Social Security benefits. The good news is market events do not impact pension payments and Social Security benefits. Remember that Social Security benefits can amount to hundreds of thousands, sometimes millions of dollars of income, which raises the income floor.
Reassessing Portfolio Structure
One assumption that might require a more drastic change could be the role interest rates play in a person’s income portfolio. Before the crisis, interest rates were already at historic lows, putting pressure on investors relying on yield-bearing vehicles, such as CDs and Treasuries. The crisis has almost ensured that interest rates will remain low for the foreseeable future. That certainly hurts retirees relying on those sources for a portion of their income, and it doesn’t help pre-retirees who are transitioning their portfolios to a lower-risk allocation. It doesn’t bode well for portfolios with corporate or government bond allocations because, once interest rates begin to increase, the value of those bonds will decrease.
That raises the question of whether pre-retirees should consider a shift towards equities, specifically dividend-paying stocks, as a way to shore up their income sufficiency. But what if there’s a significant market downturn between now and the time I retire? Well, what if it does? The reality is, while a stock market decline can impact the value of your portfolio, it won’t necessarily affect your paycheck.
In a recent blog post, What Retirement Investors Get Wrong About Retirement Planning, I discussed the pervasive myth that retirement income generation relies on the value of your assets. In reality, with the right portfolio structure, there isn’t any correlation between asset value and income generation. When a portfolio generates “naturally occurring” income from dividend stocks or bonds, a market downturn impacts the value of those investments, but it doesn’t impact the income they generate.
At this stage, the best thing pre-retirees can do is to home in on the right assumptions, perhaps making some adjustments to their objectives or their lifestyle costs if necessary. Then, it’s a matter of determining whether their portfolio is still structured in a way that can hit their targets. With a well-conceived strategy, pre-retirees should be able to weather this storm.