So said American actor and playwright Orson Welles who had generous helpings of both during his life with bad luck tipping the scales. (Read My Lunches with Orson for more on this fascinating and ill-starred man.)
One word that doesn’t come up a lot in investing circles is ‘luck’. But it should. Luck plays a bigger part in total returns than most of us would care to admit. It’s an especially crucial ingredient during our retirement years. And, unless you’re a rishi, it’s something you have absolutely no control over.
Students of finance learn about the Time Value of Money. This is the concept that present money is worth more than future money due to its earning potential. For example, if you have a million dollars today and invest it, it will grow to more than a million dollars in 20 years. Getting a million in 20 years time is therefore worth less than getting it now. (Layperson’s Translation: “A bird in the hand is worth two in the bush”.)
If you have the good luck to retire on the cusp of a secular bull market, your investments will continue to grow even as you distribute them in the form of income and gifts. On the contrary, if you happen to retire when the market is tanking, (or inflation is growing), you’re going to burn through the funds much faster. This is part of what makes up the Time Value of Fluctuations.
Here’s a nifty example: Say your portfolio loses 5% this year. No biggie, right? Next year it’s going to have to make 5.3% to break-even. That’s achievable. Now let’s take a 30% loss. To break-even you’ll have to achieve a return of 42.9%. How likely is that? An 80% loss will require a 400% increase. (In other words, Game Over.)
Capital depletion, (through market crashes, inflation or a too-rapid withdrawal rate), means that, even when the markets bounce back, your particular bounce is going to be relatively small because you’ve got less capital to propel it.
So, what to do?
First, open a bottle of wine and pour yourself a glass. If you’re on the cusp of retirement, pray for a bull market that never ends or a large inheritance.
Or you can do the following:
- Try not to exceed an annual withdrawal rate of 4%.
- Find other sources of income like a part-time job, or delay retirement until you have a topped-up nest egg.
- Make capital preservation a priority in the early years of retirement. Getting walloped in the first four years could permanently crush your portfolio. Some advisors even suggest moving all your assets into GICs and T-bills at first to ensure the safety of the capital. (This has tax implications so do the math first.)
- Set aside 1-3 years of income in money market funds so you don’t have to sell assets at a loss during a market downturn.
- If you don’t have a defined benefit pension plan, consider buying an annuity that pays out a steady income regardless of market conditions.
Luck is the ghost in the machine. You know it’s there. Don’t get spooked.