The article “What Should Retirees Do With Their Investments Amid COVID-19?” was originally published on MoneySense on March 23, 2020.
With North American stock markets down more than 30% from their recent highs, Canadians who are retired or close to retirement are faced with a choice—to sell or not to sell?
The speed and severity of the decline in global stocks and the potential for further losses have a lot of people wondering if they should sell now and protect their retirement savings. Canadians who are close to retirement or recently retired are particularly at risk. There is a risk that stocks could fall further. But there is also a risk that selling now means an investor may not recoup their losses when, not if, stocks recover.
Let’s start by summarizing what we know about the current situation, and the historical context. The Toronto Stock Exchange is trading at the same level it was at in March 2006—14 years ago. In the U.S., three of the largest 20 daily percentage changes in the S&P 500’s almost 100-year history have occurred this month. Global stocks, as represented by the MSCI World Index, are down more than 20% year-to-date.
Interestingly, the Chinese stock market—the Shanghai Stock Exchange Composite Index—is down 10% year-to-date, making it one of the best performing stock markets.
According to Invesco, the average bear market since 1957 has lasted just under 12 months, and the average loss has been 34%. In 1929, at the outset of the Great Depression, U.S. stocks took 30 days to fall 20% and enter a bear market. This recent downturn took only 16 days—the fastest bear market in the history of the S&P 500.
Before deciding how to react to the current COVID-19 fuelled situation, it is important to consider the math behind stock market declines. If stocks fall 10% five times, you would think they would be down by 50% (10 x 5). In fact, they would be down 41%, because each subsequent loss is based on a lower starting value. I know that may be of little consolation, but the math gets better.
If you have a balanced portfolio of 60% in stocks and 40%t in bonds—a common, moderate-risk asset allocation—a 30% decline in stocks might decrease your portfolio value by 18%. Once again, that may not be enough to ease your fears.
What about considering what tends to happen after stocks fall 30%? Ben Carlson of Ritholtz Wealth Management wrote a great post about the 12 previous bear markets that have been worse than the current U.S. stock market decline. He notes the average 1-year return from the market’s bottom has been 52%, and even the worst 1-year return has been 8%. We do not know if we are at the bottom yet, of course, but the point is that stocks tend to perform well in the year following a large decline. The average 3-year and 5-year returns have been 89% and 132% respectively.
What this tells us is that even though stocks could be lower a year from now, there is a reasonable likelihood they will be higher in the medium term, and the longer your time horizon, the more likely stocks will be higher (and even much higher).
If you own an individual stock, particularly shares of a small company, it is possible that one company could go bankrupt and its share price could go to zero. If you own a diversified portfolio of individual stocks directly, or indirectly through a pooled fund, mutual fund or exchange-traded fund, keep in mind the stock market itself will not go to zero. Despite any potential criticisms of capitalism, it is good at making money.
This stock market decline may or may not mean you need to reconsider your retirement date, potential spending in retirement, or other factors. But the same could happen if you lost your job, had an unexpected illness, or had to lend money to one of your kids because they were going through a divorce. Retirement planning and financial planning, in general, are fluid exercises that require revisiting and revision.
If you are within a couple of years of retirement, the good news is you probably will not need any of the money in your investment portfolio for a couple of years. And even then, you may only need to withdraw a small portion of your investments within the first few years of retirement.
If you are already retired, hopefully your investment withdrawals are no more than 5% of your portfolio value, and hopefully less, but can differ depending on individual circumstances. The TSX is yielding about 3% right now, the S&P 500 is yielding about 2.3%, and the FTSE Canada Universe Bond Index is yielding about 2%. Dividend yields and interest rates could fall, but 2% to 3% or more of your required withdrawals may come from income as opposed to from capital. If you are only going to need to sell a small percentage of your stocks over the next few years, the bulk of your investments has time to recover.
I have a client who, despite my hesitation, sold all their investments this week and put the proceeds into a GIC. I worry that may turn their temporary losses into permanent ones, and their potential future investment return given today’s historically low interest rates is virtually nil. Regardless, it was the choice that made the most sense to them.
We had a MoneySense reader ask about cashing in their RRSP and putting it all into a GIC in their TFSA. Not only would this result in the same guaranteed loss with low future return potential, but it would trigger unnecessary income tax payable on their RRSP withdrawals—a double whammy.
One of the risks of knee-jerk reactions at a time like this is not fully understanding the repercussions. Investing involves taking on risk, but with a diversified, risk-appropriate portfolio, it can be an educated risk. There have been 16 bear markets during which stocks have fallen 20% from their peak since 1926, an average of about once every 6 years. Stocks were always going to fall 20% or more at some point. If it had not been for COVID-19, the fall may have happened in 2021 and it may have taken a year instead of a few weeks. The point is that this was bound to happen. And this will not be the last time.
Retirees with Registered Retirement Income Funds (RRIFs) can take some solace in the fact the federal government announced this past week that RRIF minimum withdrawals have been reduced by 25% for 2020 as a temporary measure. This may reduce the required sales of depressed stocks for retirees, but will not help much for those who need their RRIF withdrawals to live on and who cannot afford to take out less.
Young investors should consider this recent stock market decline a buying opportunity. Stocks are on sale, and there may be 5 to 7 more bear markets like this for a 25-year old between now and retirement. Expect this to happen again.
The stock market volatility this month and the speed with which stocks have fallen is really concerning to everyone, including me, both as a financial planner and as an investor. Stocks are leading indicators and reflect expectations about future corporate profitability and the economy. Stocks are already pricing in a recession, and by the time the economic numbers (many of which are lagging indicators) confirm a recession, stock markets may already be on the rise again.
So, although stocks may still fall further from this point, they literally cannot fall forever. Stocks will recover, as will Canada and the rest of the world.
This is a scary time to be an investor, and an even scarier time to be a business owner, an employee, a politician, a health care worker, a parent or a child. My mother used to tell me “this too shall pass.” Sometimes it is hard to believe that when you are in the thick of things, but I caution investors from making rash decisions with their investments at a time when it may be difficult to envision the long-run implications.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.