Living on Your Investments? What Happens When a Bear Market Hits?

Many people follow a buy-hold strategy when it comes to investing: You know, just hold on to your stocks through the bad times, and you’ll be all right in the end. Is it true? I don’t think so.

I think buy-hold is a dangerous philosophy, especially if you are a retiree living on your investments. Bear markets tend to occur every three years on average (we are way overdue) and could devastate your retirement nest egg if you keep it in the market.

Let’s examine what could have happened if you had hypothetically invested $1 million in an S&P 500 index fund that exactly tracked the S&P 500, which did not charge any internal expenses or fees. You did not incur any external investment management fees for managing that fund, and you “stayed the course” during a period that included bear markets.

In January of 2000, the S&P 500 was at 1441. In January 2018, the S&P 500 reached a new all-time high of 2872, almost doubling over that 18-year period. Using the rule of 72* to find your rate of return, you’d divide 72 by 18 years and find that your investments averaged a 4% return. Had you drawn 4% each year from your investment, as many people say you should to cover your retirement cost-of-living, you might think you’d would still have your original $1 million today.

Unfortunately, you’d be wrong.

To begin with, you have to consider inflation. A million today does not have the same purchasing power as $1 million 18 years ago. Taking that into account, the $1 million you started with would actually be worth about $600,000.

The other issue is that the S&P 500 index didn’t deliver 4% evenly over that period. It fell close to 50% over the two years of the Y2K bear market, and you would have compounded that loss by taking out the 4% you needed to live on. The same thing happened during the 2008 bear market: The S&P 500 fell approximately 57%, but with that additional 4%, your money would have been depleted by over 60%, leaving you with less than 40% left. Farmers call that “eating your seed corn.” If you eat your seed corn, you’ve got nothing left to plant when growing season comes.

And there’s another problem: If you’re like most retirees, you probably wouldn’t have had 100% of your money in stocks. If you had a 60/40 stocks/bonds split, your actual rate of return for the stock allocation would have been closer to 2.4% over that 18-year period. And remember, you were still taking out 4% all that time, eating more and more of your seed corn. Never mind getting ahead — it would be tough to recoup even the initial investment under this scenario.

There’s an old expression: It’s not how much you make that matters, it’s how much you keep. If you want to keep more of your money, I believe that buy, hold and sell is a much better strategy than buy-hold. Using our buy, hold and sell strategy, we counseled our clients to sell in November of 2007 and stay out until June of 2009. I believe that buy, hold and sell can help you avoid losses during bear markets and protect the investments you need to live on during your retirement.

Some may say that I advocate timing the market. Nothing could be further from the truth. What I do advocate is that you consider a stop-loss order when investing. To do this, you would set a tolerable percentage loss below the previous high your investments reached, and sell when you reach that stop-loss point. Another great thing about a stop-loss: As your investments grow, your stop-loss point should rise along with them.

Watch for future articles where I will discuss how to set stop-losses (there are some things to be careful about, especially in volatile markets), where to consider putting your money once you have sold, and how to create a strategy for buying back into the market afterward.

* The rule of 72 is an equation that estimates the number of years required to double your money at a given annual rate of return.

This article provided by NewsEdge.