A new study by T. Rowe Price draws an interesting lesson on investing: the best strategy to surviving big stock market losses is to cut spending for about three years after bear markets. The study looked at investors who retired on 1/1/2000 with a portolio of 55% in equities and 45% in bonds, taking monthly withdrawals of 4% on all assets in the first year and then giving themselves a 3% inflation adjustment thereafter. Based on normal expections, in 2000, they had a 89% chance of a successful plan (i.e. not running out of money). Then the bear market of Sept 2002 hit and those odds dropped to 46%. The odds moved up and down for ensuing years but dropped to an astonishing low 6% chance of success after the next bear market but ended at 29% as of 12/31/10. These figures assumed that the investor did nothing and continued withdrawing funds as planned.
However, the study goes on to show what would happen if the investor employed certain strategies such as…
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Reduce withdrawals by 25% for three years after each bear market bottom
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Maintain same withdrawal level without the annual inflation increase for three years after each bear market bottom
- Switched to 100% bond portfolio after first bear market in Oct 1, 2002
Option #1 reduced the original 89% to 84% (as of 12/31/10 results). Option #2 reduced it down to a 69% but Option #3 actually dropped it to a 0% chance of success. Why zero? Those investors who switched to bonds (or even ‘panicked’ and cashed out) locked in their equity losses and missed out on the ensuing market rebounds.
The possible takeaway from this study? Your chances of success don’t need to rely on the “brilliance of a market timing strategy” or the volatility of the stock market. Your success can rely on YOU and your willing to take the measures needed to weather each storm. Maybe you can’t make a 25% reduction in income for three years but perhaps you could do a lower percentage but for more years. You could also adjust your expected plan by reducing expenses, which you would probably already feel like doing if all your neighbors and friends were tightening their belts. Other steps could include working a few extra years before retirement, postponing big purchases, or doing part time work. Any combination of adjustments will help. Your success is in your hands and a good financial advisor should help you through these decisions, not just count on the next bull market.