Is buy and hope a slippery slope right now?
My daughter is expecting, and I am certain our new grandchild will be a Central Banker, since she is having an uncontrollable craving for baloney. The economic mythology that has driven Central Bankers worldwide to drive interest rates to all-time lows is beginning to stimulate inflationary trends the same way that printing presses did in the past. And that in turn has had an impact on the much heralded 4 percent safe withdrawal rate that Bill Bengen promulgated in the mid-1990s to describe the rate of withdrawal that a retiree could take from their earnings and principal, and secure a lifetime income stream.
The increasing inflation headwinds were commented on by esteemed economist Martin Feldstein in the Wall Street Journal. Many financial planners and economists now believe that the safe withdrawal rate is well below 4 percent. Lifetime income options like fixed indexed annuities are ideal in this environment or when the market corrects multiple times over a retirement horizon. So what about the age-old theory of buy and hold?
Buy and hold is a passive investment strategy in which an investor buys a diversified portfolio and holds for a long time period, regardless of the ups and downs. Does this create an unnecessary risk, especially for retirees in the “red zone” prior to retirement, now that we are 64 months into the fourth longest bull market in history, according to Franklin Templeton Mutual Fund Group?
See also: Why buy and hold still works
Let’s say a client has a total of $500,000 by age 55 and the monies are diversified between various asset classes. Applying the rule of 72, if a client earns an average of 7.2 percent for the next 10 years, at age 65, they would have $1 million, at age 75, they would have $2 million and by age 85, they would have $4 million (assuming no withdrawals). [The rule of 72 is for illustrative purposes and does not reflect an actual investment as investment values will fluctuate.]
What happens with traditional buy and hold when a loss is experienced in the same hypothetical portfolio? Let’s say that the client retired and immediately suffered a 50 percent market loss in the first year of retirement. This is called lousy timing or luck in worldly times, or sequence of returns risk, in financial jargon. The portfolio is now worth $250,000, but the client decides to hang in there, ride it out and double down. The client does exactly as instructed, and the market comes back and averages 7.2 percent from there forward so that the client at age 85 now has $2 million instead of $4 million in the above.
What was the cost was of buy and hold for similar investors in 2001 and 2008? Hypothetically, it would have been $2 million. Because of portfolio losses, the rule of 72 worked on a smaller value resulting in a reduced value for their portfolio. Conversely, many clients who invested in a fixed income investment or fixed indexed annuity have, hypothetically, sacrificed double-digit returns, according to Standard and Poor’s over the last five years, but they have benefited from mitigating retirees' greatest concern, outliving their income, according to Allianz. Time in the market will always be more important in some opinions than timing the market. However, when we don’t have much time on this earth, cooler, saner, calmer heads should prevail when losses can’t be made up.
In conclusion, theories like buy and hold and withdrawal rates are like Santa Claus, the tooth fairy and Central Bankers in uncharted economic waters. They walk down the street, find a million dollars and guess who picks up the money? The Central Banker, of course, because the other two are mythical creatures.
Beware of the rule of 72 deep into bull markets and deep into retirement. Instead look to options like a personal pension or private pension that can provide a tax-free or tax-deferred alternative and an income for life. In addition, these hybrid lifetime income options can be utilized for a number of flexible needs in retirement, such as increasing income, confinement, chronic illness riders, and even unemployment.