by Chad White
Is there a significant difference between investing while working and investing during retirement?
The Accumulation Phase
In finance we refer to the working years as the accumulation phase of your life. During the accumulation phase most people’s goal is to build substantial savings and investment accounts which will last throughout their nonworking years also known as their retirement. During the accumulation phase many people’s objective is to invest in the stock market so that they can participate in the growth of US & Foreign corporations and economies. The objective is usually for high growth as people are looking to amass as much money as they can before retirement. During the accumulation phase many people are adding to their investments on a monthly or annual basis whether it’s through profit-sharing plans, 401(k)s, or IRAs or other type of retirement tax-deferred savings plan. The investment strategy known as dollar cost averaging can potentially help investors purchase shares at a lower average price. And therefore helps them to avoid trying to time the market and rather than worrying about whether the market is up or down, if they are always purchasing shares on a consistent basis they will be purchasing some shares when prices are higher and other shares when prices are lower and hopefully will have an overall lower cost. During our working years, if we don’t have a sizable account it can be actually beneficial if the stock market goes down a lot because we are still buying shares at cheaper prices and that can help us a great deal in the long run. During our accumulation phase, a lot of our investment life is almost put on autopilot sometimes by the companies we work for by contributing to a 401(k) monthly for example or by setting up a profit-sharing plan whereby you contribute money periodically, automatically.
The Distribution Phase
However, things change when you retire and you transition from the accumulation phase of life into the distribution phase of life. Retirement is the distribution phase of life because your life savings will now be distributed periodically for you to live on, and it’s like dollar cost averaging in reverse. When you were working you were putting money in on a monthly or yearly basis and now that you’re retired many people are taking money out on a monthly basis for their living expenses. We will briefly explore the difference in the two phases of life. .
Losses during retirement could potentially be significantly more impactful, while a loss in the Accumulation phase may have less of an impact because you have more time to recover. Let’s illustrate with a mathematical example. We are not referring to any specific investment returns in these examples it is simply basic math and your results may vary. If while you’re working you sustain a 30% loss in your account it will require a gain of 43% to get your account back up to the previous value. What happens in Retirement if we are drawing money out each month and we sustain a 30% loss in our investment account? Let’s assume a 4% withdrawal rate. If we are withdrawing 4% and we sustain a 30% loss in our investment account we need to recover 63% in our investment account over the next three years in order to have our account recover to its previous value. See Jim Otar (The Time Value of Fluctuations). That’s how dollar cost averaging in reverse works, large losses especially during the distribution phase of life (retirement) could potentially have a devastating effect on a retirees account value and ultimately their standard of living.
Most financial planning software assumes a specific rate of return each year. Using the previous example you can see that if you have a very bad year in your investment account during retirement that can really throw a monkey wrench into the financial plan, to the point where the plan may not be worth the paper it’s written on. Some retirement plans that were put together back in the late 90s after the tremendous stock market gains in the Bull Market period from 1982 to 2000 and they may have assumed unrealistic withdrawal rates. Then from January 2000 to August 2002 the S&P 500 lost 49%. From January 2008 till March 2009 the S&P 500 again lost 56% and some investors who tried to ride out the bear market in a typical 60/40 stock to bond portfolio allocation lost 30% during those times. See The Journal of Investing. Most Financial Planning software doesn’t allow for 30% declines yet they do happen. Working with a financial adviser who understands the difference between the accumulation and distribution phase and understands how differently retirees need to invest could be one of the informed decisions you make when pursuing a comfortable retirement.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.
Dollar cost averaging involves continuous investment in securities regardless of fluctuation in price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.
Asset allocation does not ensure a profit or protect against a loss.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
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