Should You Retire in a Bear Market or Bull Market?

that starting conditions at the outset of our retirement can give us a little bit of a clue as to how the market might behave at least over the first 10 years of our retirement and this is another slide I love because it depicts two different sequences of returns so on the left hand side of the slide is the actual sequence of returns that a retiree cutting out of work in the early 1970s would have had and I mentioned earlier on it was a bad Market environment so bad Equity returns bad Bond returns due to Rising interest rates and high inflation for a good part of that period so someone with a five hundred thousand dollar portfolio using a five percent withdrawal rate over that specific very difficult time Horizon early on in retirement would have spent through his or her portfolio within 20 years and that's what we think of as a retirement fail because typically when you embark on retirement if you're say in your mid-60s you want to be sure that your portfolio lasts 25 or 30 years at a minimum so to have spent through your funds within 20 years is a retirement failure it's not something that we'd want to emulate obviously the right hand side of the screen shows the sequence of returns exactly flipped where the great returns we had for a good part of the 1980s and in the early 1990s occurred at the beginning of that 20-year time Horizon so assuming the same 500 000 portfolio the same 50 percent stock 50 percent Bond mix the same five percent withdrawal rate that person at the end of that 20-year period would have not only met his or her distribution needs so the person would have taken the cash flows from the portfolio and spent those but the portfolio would have also grown very nicely during that time Horizon and again luck of the luck of the draw we're assuming a much more fortuitous sequence of events where you have a good bond market a good stock market fairly low inflation all of those factors redowned to the benefit of being able to take more from the plan so this goes back to that slide I already already showed you that the right withdrawal rate really depends on the specific time period and the specific Confluence of marketing Market events in play during that drawdown period so if we're thinking about our own retirements I think it's helpful to put a little bit of a dashboard together where we're looking at some of these key variables and making some assessments about whether we think things might work in our favor or things might work against us so the ideal conditions for starting withdrawals would be that you'd come into retirement with low Equity valuations so stocks are cheap and during your retirement you're able to sell them off to meet your cash flow needs and you're able to sell them at ever higher prices so low Equity valuations would be a good thing to come into retirement with decent cash and bond yields are another huge plus that's something that retirees did not have in the previous decade it's looking a lot more favorable thanks to Rising interest rates that people will have that safe footing in safe Securities with a higher yield and finally low inflation is another big plus if you can come into retirement with the sense that is it that inflation is pretty low and there are no clear catalysts for it going higher that definitely is beneficial to the plan and it can help improve starting safe withdrawal amounts so the flip side is also true poor conditions for starting portfolio withdrawals would be that stocks are expensive at the outset of retirement that cash and bond yields are very very low and that inflation is high and the reason High inflation early on in retirement and I'll hit on this a little later on the reason why that's such a Negative is that high inflation reduces the purchasing power of our portfolio cash flows so even if we are able to get a higher yield from our portfolio if we're having to haircut those yields by inflation that cuts into our actual spending so high inflation is certainly a negative as we think about starting conditions for retirement withdrawals the good news for people who are thinking about retirement right now or for or perhaps for those who have just retired is it 2022 even though it was a painful Market in many respects does foretell better things for new retirees so we had stock prices fall we had bond prices fall at the same time largely because of rising interest rates just a handful of categories managed to perform well last year Commodities and that yellow line in my slide is the one that did manage to Buck the trends but if you had a fairly vanilla portfolio you probably saw losses in your portfolio last year it wasn't a comfortable year it wasn't an easy year but the good news is is that the fact that we have depressed stock prices and certainly bond yields coming up due to depressed bond prices that conspires to make market conditions more more attractive for new retirees today so this is a look at our price to fair value graph that our analysts put together based on their bottom-up research for the individual companies that they cover and I'll just explain what we're looking at here in case you're not familiar with this graph and this is part of the Morningstar investor website this is an aggregated price to fair value for all of the companies in our Global coverage Universe when our analysts are tasked with covering individual companies we asked them to come up with what they think is a fair value for that company based on their own discounted cash flow analysis so to use a simple example if a company is trading at eighty dollars and our analyst thinks it should be worth a hundred dollars the price to fair value would be 0.8 on the other hand if the share price were a hundred twenty dollars and the analyst thinks it should be worth a hundred dollars well then the price to fair value would be 1.2 so this is the aggregated price to Fair values for all of the companies in that Global coverage universe and what you can see is that this bounces around a little bit that there are various points in time where the market looks expensive to our analysts so for a good part of 2021 for example you can see that our analysts thought again based on that bottom-up research that stocks were looking frothy but then when the market sold off in 2022 you can see that the analysts thought that stocks looked a lot more reasonable at that time so when we look at price to Fair values for that Global coverage Universe today you can see that the typical company is trading at about a 10 percent discount to fair value that's a better condition for starting retirement withdrawals than would have been the case even a year ago or a year and a half ago when valuations were higher the good news is that we see this under evaluation across the style box it's just not just concentrated in a single area although you can see on this slide that our analysts are finding the cheapest stocks in the small cap rung of the style box but generally speaking this is broadly dispersed under valuation that even large companies stocks whether value or growth look inexpensive to our analyst team so that's a good news story another good news story and this is one that we've been beating the drum on a little bit for the past few years is that the undervaluation does appear to be not just in the U.S but across the globe in fact there are other major markets where our analysts price to Fair values are a little bit more attractive than in the U.S than in North America today so that's good for food for thought if you haven't rebalanced your portfolio or haven't been wanting to give much attention to any International Holdings in your portfolio this suggests that you might consider doing so simply because of relatively attractive valuations in non-us stocks another factor that bodes well for new retirees and I hit on this earlier is just the fact that we've seen yields come very far in a very short period of time so these are 10-year bond yields across geographies and you can see that most major geographies have moved higher in terms of their yields U.S has kind of led the way but other countries have certainly been raising interest rates to combat inflation as well even even Japan which is that bottom line there it has been raising interest rates very recently which is a relatively new phenomenon for Japan all of this redounds to the benefit of bondholders if we have higher yields on offer when we are when we're embarking on retirement that portends well for the starting safe withdrawal rate so this is a good news story in many respects even though we have at a difficult Market environment for 2022 for bonds that it sets Bond investors up with better conditions than they would have had a year and a half ago because we know that there's a very tight relationship between bond yields starting bond yields and subsequent Bond returns over the next decade this is a slide that is a compilation of the various Capital markets forecasts that try to put together at the beginning of every year and sometimes within periods of Market disruption I'll gather uh the capital markets forecast from various firms including our team at Morningstar Investment Management as well as other firms outside of Morningstar Black Rock Vanguard and so on in my latest rundown of capital markets forecasts what I found were much better Equity return prospects and certainly fixed income return prospects than was the case when I did the same exercise at the beginning of 2022. back in 2022 most firms were expecting Bond returns to be in sort of the two percent range Equity return expectations were also much lower so this is just another reinforcement that the starting conditions for retirees embarking on retirement today look a lot better better than they did even a couple of years ago one thing I would point out on this slide is that the capital markets forecast for both developed markets equities and Emerging Markets equities look a lot better than is the case for U.S equities this has been kind of a consistent theme in these Capital markets forecasts it really hasn't changed even though we did have a sell-off in the U.S Equity Market in 2022 Global markets generally sold off as well so the valuation Advantage for non-us stocks is still there despite 2022. again if you haven't rebalanced might be a consideration to to do so whether you're retiring or many years from retirement so the good news is when we have better market conditions better expected stock and bond returns that lifts what is a safe starting withdrawal amount so when we did our research on starting safe withdrawal amounts in the 2020-2021 period our conclusion was that a 3.3 percent starting safe withdrawal rate had a 90 percent probability of success with a balanced portfolio over a 30-year time Horizon when we Revisited the research last year so in the at September 30th 2022 we came up with a better number a 3.8 percent starting safe withdrawal rate in part in large part because market conditions had approved have improved along the lines of what I just discussed so before we go any further I just want to underscore the assumptions that we use in coming up with these calculations so first of all we're using a fixed real withdrawal system so we're assuming to use my base case we're assuming that someone is withdrawing 3.8 percent from that portfolio in year one of retirement and they're then they're inflation adjusting that dollar amount thereafter so to use that 3.8 percent number with a one million dollar portfolio that would mean 38 000 in year one of retirement and then assuming a three percent inflation rate you get to take 39 000 and change in year two so the idea is that the retiree wants more or less a paycheck equivalent kind of a fixed level of real spending throughout the retirement time Horizon that may or may not be the what the retiree wants but that's the base case that we used and that's very much the convention when we talk about starting safe withdrawal rates we used a balanced portfolio Leo and again we used a 90 success rate we targeted a 90 percent chance of not running out of funds over the time Horizon so this is a good news story that uh starting safe withdrawal rates are higher but the bad news story and I think I have to address it is the fact that investors saw their portfolios decline last year so 3.8 percent yes it's a higher number but your portfolio balance very likely is down a little bit so it may be roughly the same maybe even a little bit less than would have been the case with that 3.3 percent on a higher portfolio balance

Channel: Morningstar, Inc.

Views: 3,400

Keywords: morningstar, investing, stocks, funds, etfs

Id: OIJJMyklWtY

Length: 15min 10sec (910 seconds)

Published: Sat Aug 05 2023