A Cautionary Tale
In the summer of 1999, I started working with a couple who had retired two years before. They were both age 62 when we met, and they had worked hard & invested for decades. This couple retired without a financial plan, and so their estate attorney introduced them to me. Their financial plan results projected them to be on-track. One reason was because I had painstakingly educated them on how to withdraw income from their portfolio at a prudent rate each year. In addition, their existing portfolio was a carefully designed blend which was partially high-grade bonds, and partially high-quality stocks.
- The bonds were there to seek to help fight 1 of 2 main financial risks to retirees, which is down cycles in stocks.
- And the stocks were there to seek to help fight the other main risk, which is the ever-present and insidious rising cost of living (inflation).
The income this couple needed for the rest of their lives depended on this blend of bonds and stocks being in place for the rest of their lives. Their portfolio blend matched very well with the couple’s goals in their financial plan. This couple had stacked the odds of financial success in their favor, as long as they diligently updated & followed their plan.
Fast forward to the winter of 2002. This same couple was enduring a temporary-but-miserable stock market down cycle, punctuated by the brutal bursting of the technology bubble. One which brought the Dow Jones Industrial Average stock index down -38% from its high of 11,700 to 7,200. For comparison, today the Dow stands at about 33,000. (source: FactSet, Inc.) Bear markets are never easy, always very scary. And similar to every bear market, the human mind tends to think “It’s different this time. This is uncharted territory.” Because it IS different each time. The 2000-2002 down cycle was uncomfortable.
Of course, this couple had a diversified portfolio which included high grade bonds, by design. And their plan was still strong, as was their portfolio………even though the portfolio’s value was temporarily sagging. Both the portfolio and financial plan had been built expecting down cycles just like that one to happen. And not just once, but multiple times over the rest of this couple’s lives.
Unfortunately, this couple could not draw themselves to focus on the rest of their lives. They were laser focused on the current negative news, stock prices day-by-day, and the value of their portfolio (“It used to be worth more!”). They could not see the big picture. They would not listen to reason, or logic. All they could think about was the $75,000/year of income they needed in 2002 to continue to live their retirement life. In a moment of desperation, they panicked. They jettisoned their critically important portfolio structure and abandoned their financial plan……..by selling out their diversified portfolio and moving to cash & super short-term bonds.
The result? Suddenly they owned an extremely conservative, but also likely lower-returning, portfolio. Instantly they felt relief. The pressure was gone. In 2002 I remember them saying “Best thing we ever did! We feel so much better. We will never go through that again.” But the relief was only short-term. They had traded momentary solace for a lifetime of quiet financial desperation.
Fast forward to 2022. Twenty years had passed, and the husband and wife were age 85. Over the previous 20 years, the cost of living for this average retired couple, simply due to normal every day inflation, had steadily creeped up by about +2.9%/yr. (source: Morningstar, Inc.) So this couple, who needed $75,000/year back in 2002 to stay retired, now needed $145,000/year to live the same exact life 20 years later. Almost a double. Their original portfolio and financial plan, the ones they tossed in the garbage in 2002, had planned for this inevitability. But that didn’t matter in 2022. They discarded those 20 years ago when they panicked. Had their very careful 100% cash/short-term bond portfolio been able to keep up with their spending need? No. (source: Bespoke, Inc.)
Many years before, this couple started cutting back. Vacations, gifts for the grandkids at the holidays, helping with college costs, new clothes, dining out together………it was all on the chopping block every year for the last 20 years. Just to cover essentials such as keeping the lights on, paying for heat, and paying real estate taxes. And they prayed neither one would need to pay for extended nursing care. For those 20 years, they had been hurtling towards financial destruction on the installment plan.
While none of those 20 years had been spent worried about the direction of the capital markets, all of them were filled with worry about the likelihood of running out of money before they died.
Sadly, this story repeats itself with a small number of investors every time the markets go through a down cycle.
I tell it to you because I have seen it happen first-hand.
Use it as a cautionary tale if you find yourself considering trading short-term comfort for long-term despair.
Afterword: For those who think “why couldn’t the couple just sell, and wait til things get better, and then buy everything back?”…
During each down cycle, it might feel tempting to try that trick. But it is an insane strategy. Nobody has ever (nobody, ever) been able to move in and out of the markets repeatedly without chopping their money into little pieces.
You have to believe…
- That there exists a human being who has the ability to literally see the future
- And then you have to believe that human being is you.
As Warren Buffett said, “Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”
Author: Rick Wagner
Opinions expressed are those of the author and not necessarily those of Raymond James. Please note, this material is being provided for informational purposes only. Investment decisions should not be based on the content provided herein. Please consult your financial advisor before making any investment decision. Past performance is not indicative of future results. Investing involves risk and investors may incur a profit or a loss regardless of strategy selected.
