Preparing for the Unexpected in Retirement

About a week or so ago, a very nice couple from Plymouth came in to see me, I’ll call them Barb and Andy. They’re in their 60s and have a son finishing graduate school who lives in Boston with his soon to be fiancée. Barb and Andy are both executives in their fields – very hard-working folks who have invested wisely over the years. Their Type-A personalities have also made them both competitive athletes – they’re the tennis mixed-doubles terror of their country club. Their active lifestyle makes them easily look ten years younger than what it says on their driver’s licenses.

Just like many of us, Barb and Andy had some setbacks along the way – layoffs and downsizing leading to a few years of lean living. The 2008 economic crisis hit their nest egg particularly hard. Thankfully, they’ve recovered and are now firing on all cylinders.

They are thinking about the next step of their lives when they can finally slow down and begin to enjoy the fruits of their labor. Andy told me about their ten-year plan: travel the world for a few years, then enjoy a growing family when their son and future daughter-in-law have kids. Barb and Andy are in no hurry to retire early – they both love what they do and envision working straight up until age 70.

I asked them why they planned to delay retiring for so long.

Andy pointed out that it took them years to recover from the battering their investment portfolio took in 2008, so they’re still rebuilding their wealth to a point they’ll be able to retire without severe austerity. While it’s only one part of their post-retirement income strategy, Andy also noted that 70 is the age at which Social Security maximizes its monthly benefit.

While you can qualify for Social Security benefits as early as age 62, you aren’t eligible for your full retirement benefit until you reach age 66-67, depending on the year you were born. But if you can hold out even longer, Social Security gradually increases your retirement benefit over 100%, reaching a maximum of 132% at age 70. Andy pointed out that by moving their retirement to age 70, they gave their investments more time to accrue compound interest as well.

All smart, rational decisions . . . but I had a few questions.

“What if you can’t work until 70?” I asked.

With confidence, Andy told me he didn’t think it’d be a problem. Their careers were secure, and he said he was proud that he and Barb were the epitome of health.

So, I asked the same question again. Andy, a bit annoyed, got even more annoyed with me when I asked, “And how would your investments behave if there’s another significant market downturn like 2001, 2002 or 2008? Have you back-tested your portfolio to see how it would do?”

“Fool me once, shame on you,” Andy said with a smile. “Fool me twice, shame on me.” Andy told me he watches the financial news like a hawk. He felt confident he’d see it coming and be able to steer their investments to safe harbors. But Barb confessed that they’ve primarily employed a buy-and-hold strategy and just ridden the rising tide of the markets.

Andy and Barb are both used to feeling in control of their destiny. They’ve worked hard for what they have. But in retirement, unfortunately, it’s often not that simple.

In fact, more than half of all retirees in the United States retire before they ever planned to, according to Fidelity. And it isn’t because they all could afford to retire early, either. Fidelity tells us that 46% retired due to health problems, 18% had been laid off or were victims of some kind of corporate restructuring, and 11% had to retire to care for a loved one. Some folks had more than one reason.

Having to retire early can have profound consequences for individuals who are unprepared. A study by the Urban Institute shows that retiring five years sooner than expected can translate to a 36% reduction in retirement income. That’s five fewer years to build that nest egg, and five more years to pay for medical expenses that would have been underwritten by an employer’s health plan. Social Security benefits are based on the average of your top 35 years of income, and the years before retirement are often the most lucrative. Five fewer years of top-earning income might mean a lower Social Security check, as well.

I was reminded of the great Scottish poet Robert Burns, who wrote “The best-laid schemes o’ mice an’ men gang aft agley.” (“The best-laid plans of mine and men go oft awry.”)

Folks, you can scrimp and save and plot and plan, but you can’t prepare for everything.

Barb and Andy hedged their investment strategy on the idea that their health and employment will remain constant and steady until the time they’re ready to retire. If I were a betting man, I’d give Barb and Andy better odds than many, but it pays to prepare for the unexpected. Barb and Andy are also assuming they can see a problem with the markets coming before it happens.

You see, Andy was counting on often outdated main-stream financial news and his gut instinct reaction to make financial decisions. That’s not an appropriate strategy for any investor, let alone one with retirement in his sites. The couple spent years recovering from the last significant economic downturn we experienced in 2008, and they don’t have the time to rebuild if there’s another event. They’re running out the clock.

So, we went to work. We began by back testing their portfolio using data through 2008. It became crystal clear to both of them that if they kept with their same outdated strategy, well, it was not good. They could face a potential repeat of their 2008 performance with a potential loss of over 40% of their net worth if the market tanks again.

Hmmm . . . they now saw the problem.

While they’ve done a great job rebuilding their wealth for the past decade, they hadn’t realized how much downside risk they’d exposed themselves to over the years. I explained to Barb and to Andy that they must look to manage downside risk first.

We decided to implement a combination of strategic and tactical investment strategies. A strategy that incorporates risk triggers to help mitigate their downside risk. Risk triggers that use moving averages to help investors see the forest through the trees and to recognize long-term market trends rather than day-to-day fluctuations in security prices. A strategy that uses quantitative data instead of gut instinct which will help Barb and Andy to capture upward market gains while providing a safe harbor when the market trends downward. Through implementation, we were able to reduce their exposure from over 40% to roughly 14% – a much more appropriate level of risk.

Know your goals both before and after retirement. Then employ sound, proven strategies that focus on wealth preservation, managing portfolio volatility and minimizing downside risk. Hopefully, you can stick to your original plan, but using these investment principles will help to prepare you for multiple eventualities, like unexpected early retirement and a change in market conditions.

It pays to be ready.

Be vigilant and stay alert, because you deserve more.

Have a great week!

Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, a wealth management firm with offices in Falmouth, Duxbury, and Mansfield. Jeff can be reached at jeff@old.cutterfinancialgroup.com.

Cutter Financial Group, LLC (“Cutter Financial”) is a SEC Registered Investment Advisor.

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