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Stock Market Stumble Forces New Thinking on Retirement

By: Jeff D. Opdyke and Ruth Simon
Wall Street Journal, July 9, 2002

If you are saving for retirement, the stock market's plunge has been painful. If you are already retired or nearing that point, it has likely been a disaster.

The bear market of the past 2½ years has wiped away more than $678 billion of retiree wealth, according to new calculations based on the University of Michigan's Health and Retirement Study. The calculation, based on a continuing study tracking 20,000 people from age 50 until they die, estimates that there has been a 10% decline in the portfolio of the typical retiree who holds stocks directly or through an IRA.

In response, many retirees are seeking out help rebuilding their nest egg. In the first six months of 2002, T. Rowe Price handled 40% more calls to its advisory group, which provides help with retirement planning. The AARP says calls and letters from worried retirees and preretirees have more than tripled in the past year.

The losses have prompted some changes in thinking about how to invest and when to retire. Many advisers are recommending that older people dramatically restructure their portfolios, dumping their weakest holdings even if it means missing out eventual gains down the road. Some annuities are seeing renewed interest because they can offer returns higher than those on bonds. Some planners are also downgrading expectations for what people should earn in retirement.

Typical is Peter Giordano. The 69-year-old Islip, N.Y., resident retired in 1996 and lives on Social Security and his investment portfolio, which was loaded with stocks such as Lucent, Intel and Cisco. With his portfolio down by one-third, he has hired a planner and canceled a $15,000 vacation. "I don't even look at the market anymore," says Mr. Giordano, who got rid of many tech stocks but kept some of his larger holdings, such as General Electric.

Here's the latest thinking on repairing a retirement portfolio designed for better times.

Shoot the Losers: Sell battered tech, telecom and other stocks of troubled companies, says Michael Kresh, a planner in Hauppauge, NY. Many retirees might be tempted to abandon stocks altogether, but stocks are still expected to provide the best returns over long periods of time. How much you should keep in stocks depends on several factors, including age and risk tolerance. An easy gauge: Subtract your age from 115, and that is the percentage you should have in stocks; the rest should be fixed income and cash.

Build Ladders: To ensure that you meet your expenses regardless of Wall Street's gyrations, invest in certificates of deposit and Treasuries that come due at regular intervals. The securities should mature about every six months over a two- to five-year period in order to provide a steady stream of income. But investors should keep in mind that bond prices fall when interest rates rise.

While it's not clear how much of it came from retirees, more than $100 billion flowed into corporate and government bonds funds in the past year. At the same time, stock inflows amounted to $65.6 billion. Those numbers dramatically reverse the trend of a year earlier.

Buy Annuities: Some planners are once again recommending fixed annuities, sales of which hit a record $22.1 billion in the first quarter. "I hadn't looked at them in 10 years, and now I am because they have higher returns that anywhere else in the fixed-income world," says Deborah Voso, a fee-only financial planner in Frederick, Md., who notes that yields in the 5.25% range are common with these investments.

Retirees should generally avoid variable annuities, which often carry high fees and other unattractive features. Instead, look for fixed annuities in which there is a guaranteed rate of return for a period of years -- and no charge for cashing out at the end of that period. That way, investors won't be hit with big surrender charges for getting out when the guaranteed rate drops.

Spend Less: Financial planners have long advised retirees to start out by withdrawing just 4% to 5% of their original retirement assets annually so that they don't run out of money. That initial amount should be increased slightly each year to cover inflation. The high returns of the nineties led many to disregard the conventional wisdom and instead spend as much as 10% their principal each year. Now, planners are re-emphasizing this point.

But withdraw too much as the market falls, and your money can vanish long before you do. Take a worker who retired in 2000 with a $500,000 nest egg that was expected to earn an average of 9% a year and last for 25 years. That retiree could start out withdrawing about $36,000 a year. However, based on real market returns, the retiree either needs to slash spending by 29%, or earn an unrealistic 14.7% a year over the next two decades.

Reassess Risk: Many investors are getting the first true test of how well they can stomach sustained stock market losses. One test of how much risk you can tolerate, says John Markese, president of the American Association of Individual Investors, is to "take the worst case scenario ... and then determine if you can sustain those dollars going out the window." If not, you have too much in stocks.

Lower Your Expectations: The conventional wisdom long held that 10% annual returns on a retirement portfolio were attainable. In the 1990s, many investors ratcheted that up to 15% in modeling their retirement income. No more. The new mantra among many planners: Expect total returns, which include dividends, of just 7% or 8%.

Keep Your Day Job: AARP is strongly advising its members to keep working until they hit age 65, even though people are eligible for Social Security benefits at 62. AARP is particularly concerned with retirees being able to pay for health care, which continues to soar.

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