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Finished With Engines … Not Quite Yet

15418007_sThere are certain times in my professional career that I just shake my head in disbelief at what some view as acceptable advice. Last week, Cindy from the Lower Cape came to see me. Cindy is a lovely woman who just turned 66 and is retiring in January. She has saved about $850K, has a mixture of stocks and bonds, and is concerned about the volatility in the markets, particularly because she is retiring.
 
During my initial meeting with Cindy, I looked at her tax return and noticed that Cindy still has unused capital losses resulting from the 2008 market downturn. I asked Cindy if she thinks she can afford to suffer another loss like she did in 2008. She told me that she absolutely cannot, as she is no longer working and must use her investments as income to supplement her Social Security. Cindy explained that she is scared to death of running out of money and is not confident that her broker has offered her any sufficient solutions to protect her portfolio. I asked Cindy how the conversation went with her broker at the time her portfolio was down, and quite frankly, the response really took me by surprise. Cindy’s broker told her that it was “only a paper loss” and that she just “needed to ride it out.”
 
Hmm . . . Ride it out?! Paper loss?! Really?!
 
I asked Cindy if when her account goes up does her broker call to tell her that it is only a paper gain? There I go again, being flip. But, you see, it is hypocritical to say the gains are real, but the losses are not.
 
Although many people know that they do not want those losses, even when they are “just on paper,” most do not understand the total effect of such losses to their retirement account. Not only do they lose money, but they lose something just as valuable to their portfolio . . . time! We all know how important it is to make our funds last as long as possible during retirement. And naturally, we want to do everything in our power to make sure that we protect our savings from significant market losses. However, often, people do not understand that even moderate losses can wipe away many months and years of hard-earned savings.
 
Let’s take Cindy. She has $850,000. She worked 35 years to accumulate her hard-earned savings. (Working 35 years to save $850,000 equals about $24,000 per year, or about $470 per week.)
 
What would happen if Cindy were to lose 10 percent of her portfolio, resulting in an $85,000 loss? That represents three and half years of savings!
 
Now, consider a loss of 40 percent, which is similar to the amount of loss many suffered during the market downturns in 2001, 2002 and 2008. A loss of $340,000 (40 percent of $850,000) equals about 14 years of savings.
I explained to Cindy that if she is concerned about market volatility, then her current retirement strategy is quite risky in today’s market conditions. Let me tell you, Cutter Family Finance readers, what I told Cindy. We are in the middle of a secular bear market, and bear markets usually last about 20 years. This secular bear market began in 2000. While a secular bull market implies that stocks are steadily rising, a secular bear market does not mean that stocks are steadily falling. Instead, during a secular bear market, stocks swing wildly higher and lower in a sideways pattern for an extended period of time. And sideways swings completely define how the market has traveled since its March 2000 peaks. It has endured massive crashes with losses of more than 50 percent. And it has enjoyed incredible rallies in the +100 percent to +200 percent range. Such is the behavior of all secular bear markets going back to around 1900. Heck, even John Bogle, the president of Vanguard, believes the same to be true. He said recently on CNBC to expect two, yes two, more significant market downturns of over 50 percent before the end of the decade.
 
If Cindy remains in her outdated strategy and we suffer what Bogle says will be two more significant market corrections before the end of the decade, well, as we used to say when I sailed on ships, and we were all tied up securely at the dock . . . finished with engines.
 
Let me explain. Cindy’s classic buy and hold, asset allocation strategy that may be successful during secular bull markets (which we were in from 1982 to 2000), simply does not work now, as we are in the middle of a secular bear market. In a secular bear market, being told to “just ride it out” is simply unacceptable. Secular bear markets require a more active investment approach. Cindy must seek solutions that can capture gains made during those upswings and side step those downswings. She must seek strategies that attempt to identify investment cycles in order to evaluate market risk. These strategies will drive investment decisions, rather than simply buying and holding or “riding it out.” In a secular bear market successful financial solutions focus on capital preservation. We must be willing to give up a little of the upside performance if we can garner some of the protection on the downside.
 
Cindy must change her investment approach if she is going to have a solid retirement system. If not, she could find herself finished with engines.
 
Be vigilant and stay alert, because you deserve more.