Contributed by: Timothy Wyman, CFP®, JD
Let’s face it; market volatility isn’t a whole lot of fun for any investor—unless that volatility is on the upside, of course. When investments experience downward volatility it can be hard on the psyche. In my experience, however, there is one group that is hit especially emotionally hard: those clients that are on either side of two years from their retirement date. While those with long term horizons feel some pain, it is generally muted because the funds are needed in the distant future and it doesn’t seem to bother them as much. Similarly, those that have been in retirement for a while seem to have the “been there – done that” mentality. They have been through volatility before, hopefully have weathered past storms, and understand volatility is part of the process to potentially get fair returns over time.
But how about those within two years, either side, of retirement? Often times, these clients are the most concerned, and rightfully so. The time that folks switch from being a net saver for so many years to a net spender is emotionally challenging in many cases. As former partner Dan Boyce used to say, it feels like you are eating your seed corn. (Full disclosure – this city boy never really understood it but many a client nodded as if to confirm the saying!).
According to research underwritten by Prudential Securities, “economic researchers have found that emotions play a significant role in how people make financial decisions.” At first, my response was a yawn and a hope that Prudential didn’t pay too much for such a conclusion. Fortunately there was more to the study, something with a little more meat on the bone. The study suggests that the five years before and after retirement is critical. That understanding this behavioral risk becomes even more important. Two specific risks cited in the study include sequence risk and behavioral risk.
At the risk of downplaying behavior risk, it is one that we have some control of, after all. Poor investor behavior during this two year of period within retirement can be hazardous to your financial health, for a long time if not forever. What’s the prescription? Yes this is self-serving, but working with a third party professional can help improve investor behavior. Vanguard suggests that behavioral coaching may bring about as much as 150 basis points (or 1.5%) of value add by advisors.
The second risk, sequence risk, is very real and much less controllable. Large negative returns early in retirement can indeed impact one’s retirement years. Fortunately, for many, one large loss year usually isn’t enough to derail years of proper planning. Again, what’s the prescription? In general, utilizing multiple asset classes, multiple investment styles, and multiple managers (aka asset allocation & diversification) provides enough risk parameters to lessen the potential sequence risk.
If recent volatility has hit you especially hard (emotionally or in dollars) give us a call. If you are a current client we welcome the opportunity to review your portfolio and your plan, and if you are not a current client we welcome the opportunity to provide another opinion.
Timothy Wyman, CFP®, JD is the Managing Partner and Financial Planner at Center for Financial Planning, Inc. and is a contributor to national media and publications such as Forbes and The Wall Street Journal and has appeared on Good Morning America Weekend Edition and WDIV Channel 4. A leader in his profession, Tim served on the National Board of Directors for the 28,000 member Financial Planning Association™ (FPA®), mentored many CFP® practitioners and is a frequent speaker to organizations and businesses on various financial planning topics.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Timothy Wyman and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Past performance is not a guarantee of future results. Investing involves risk and investors may incur a profit or a loss regardless of strategy selected. Raymond James is not affiliated with and does not endorse the opinions or services of Vanguard or Prudential Securities. Diversification and asset allocation do not ensure a profit or protect against a loss. There is no guarantee that using an advisor will produce favorable investment results.