Even if punctuated with days of spectacular gains, the next little while looks like it’ll be a period of sickening declines in the market. Who wouldn’t get anxious and scared by the prospect of one’s retirement nest egg melting away?
I don’t have the investment answer for preventing market losses, but I’ll share a technique that I use to help quell the anxiety: I think of the worst that can happen.
OK, let’s start with the absolute worst: I die. Didn’t expect that, did you? Well, if I died pretty soon without a long, agonizing and costly death, the money that I was putting away to live on in retirement would go to my wife and kids. So at least from the purely financial point of view, death wouldn’t be the worst thing for everyone other than me.
Second worst, probably, would be to live a very long time and run out of money. So let’s follow through on that one.
Suppose I have a $1 million portfolio. And suppose the current market declines whittle that down to a $750,000 portfolio. Over time, even if I didn’t invest another dime, that portfolio would likely start going up again as sentiment changed and dividends were reinvested. But let’s assume that I’m down 25% and have to live off $750,000.
Using a 4% annual withdrawal rate, which is approximately the rate that meets the government’s required minimum distribution guidelines, my portfolio would provide me with $30,000 a year of income instead of $40,000. After taxes of, say, 30%, I’d be left with $21,000 a year versus $28,000 a year. That would be about $403 a week in net income as compared with $538 a week.
OK, so what would be different if I had to make do on $135 a week less?
Well, my wife and I would have to cut back on spending. First, I’d seriously look at my cable and wireless bills, where I’m sure there’s lots of fat. I’d go over some of our insurance coverage, especially in personal items, and look to cut back there too. My wife and I would probably eat out a little less frequently, which wouldn’t be the worst thing for our waistlines, and we’d cut back a little on clothing purchases. We don’t drive all that much, but we’d probably be more careful about car use. And I’d make sure we didn’t leave any lights or air conditioners on when not absolutely needed.
I think that would more or less add up to about $135 a week.
It would be more fun and easier to spend the money than not to spend it, but the way we live wouldn’t change all that much. Granted, not everyone is in a similar situation and for many people a decline of $135 in weekly income would be catastrophic — but then again, we presumed having a $1 million portfolio to start with, which is the case for only about one in 20 American households.
To be sure, market declines are painful, losing money is painful, and cutting back is no fun either. But it’s useful, and not at all Pollyanna-ish to remind ourselves that we’ve endured worse in the past and we can make it through this one, too.
Image courtesy of Stuart Miles at FreeDigitalPhotos.net