Debunking the “Safe Instruments for Retirement” Myth


26 Sep Debunking the “Safe Instruments for Retirement” Myth

MOST statements in life, when repeated often enough, will be taken as the indisputable truth.

This is especially the case if our general, everyday observations sort of suggest that the statements are right. Few will stop to question their validity – what are the assumptions embedded in those statements, who made those statements and to what purpose, have robust tests been done to verify claims made in those statements.

In the field of finance, one wisdom which is often purveyed is that of life cycle investing. The theory goes that young people should be more aggressive in their investments, i.e. they should allocate a higher proportion of their portfolios to equities for the long term compounding effect to take place. But as a person nears retirement age, he or she should cut their exposure to equities and hold more of their portfolios in bonds and cash.

This makes intuitive sense. Equity prices are more volatile than fixed income instruments, and unlike the latter, there is no assurance of regular pay-outs from equities. As such, it would be “safer” for retirees, who are dependent on their life savings for their daily expenses, to park their money in a less volatile portfolio. What if the retiree had her entire life savings in equities, and saw her portfolio diminish to less than half during the global financial crisis in 2008? That would be a nightmare scenario, wouldn’t it?

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But here’s the thing.

This image of this scenario is likely to be most vivid when the stock market crash is at its worst. At that point, we see in our minds retirees with their wealth halved compared to the pre-crisis level. “Poor things!” we’d think. “That’s why, retirees shouldn’t put all their nest eggs in the stock market.”

But you know what? Market recovers even from the worst of crises. As long as a retiree doesn’t panic and cash out the entire portfolio at the bottom of the market, there is a good chance that she would see her portfolio recover.

We did a stress test on an all-equities portfolio at each of the previous market peaks in the Singapore market going as far back as 1973. Let’s assume that there were seven retirees. Each retired with $1 million and decided to put the entire sum into the stock market. The bull markets at the time of their retirement gave them confidence that the stock market was a good place to keep their savings. So each of them plonked their $1 million into the market at the beginning of 1973, 1982 1984, 1990, 1997, 2000 and 2008. And each wanted to withdraw 5 per cent from that $1 million, or $50,000 a year, to pay for their living expenses. As it turned out, the years that the seven retirees put their money into the market were the years of market peaks. Soon after, major crashes or market corrections took place.

Can the $1 million equities portfolio last them till today?


Well, six out of the seven portfolios did.

The initial $1 million portfolios were worth between $824,000 and $3.4 million as at end 2012.

For the person who retired in 1982 with $1 million invested entirely into the Singapore stock market, her portfolio as at end of last year was worth $3.4 million. This was after she withdrew $50,000 a year from the portfolio for the last 31 years. The withdrawal amounted to $1.55 million in all.

For the person who retired on the eve of the Asian financial crisis, her portfolio as at end of last year was worth $1.6 million. And in the intervening years, she had taken out $800,000 from her portfolio as spending money.


From the table above, you can see that the two who retired on the eve of the two most recent market crashes – the dotcom bubble burst in 2000 and the global financial crisis in 2008 – still had $824,000 and $842,000 in their portfolios respectively.

At five per cent withdrawal rate, the lowest the six retirees’ portfolios ever fell to was $429,000. That was for the person who retired at the peak of the dotcom bubble. But as long as there is still money in the market, there is a chance of recovery.

The only retiree whose portfolio didn’t survive was the one who put her money into the market during the massive 1973 bubble in the local market. At that time, according to data from Thomson Datastream, the Singapore index was trading at a price-earnings ratio of 35 times. It was the time when OCBC was trading at $50 a share and Metro was at $26. In other words, there was a massive bubble in the Singapore market at that time.

At a 5 per cent withdrawal rate, her money was depleted by 1984. But if she had reduced her withdrawal rate to 3 per cent, i.e. take out $30,000 instead of $50,000 a year to spend, she would have survived the numerous crashes that followed and she would still have an equities portfolio of $1.6 million as at end of last year.

For the above calculations, we use the Thomson Datastream calculated Straits Times Index as a proxy for how an all equities portfolio would have performed. Dividends are added to the portfolio. No transaction costs are taken into account. The portfolios are valued once a year on 31 Dec, and withdrawals are done on that day as well.

So what are the main takeaways from the above study?


It is that, chances of an all equities portfolio being completely wiped out at a withdrawal rate of five per cent a year is minimal under normal market conditions. The exception is when someone buys into the market at the peak of a massive bubble, as was the case in 1973.

Another noteworthy point is that as long as the portfolio is not too decimated, and so long as the money stays invested in the market, there is a good chance of recovery given time. But admittedly, the ride can be quite rough at times. The portfolio can plunge by half in a year.

The key is to hang on tight.

So the upshot is that someone who has $1 million can relatively safely withdraw $50,000 a year to fund his or her retirement for as long as they live, and yet still leave an estate for their kids if they put the entire sum in the equities market!

Time to say goodbyes to perpetuals, annuities and bonds – which usually form the core of a retirement portfolio!

But there is one very important caveat here. The equities portfolio must be made up of a diversified basket of stocks of real businesses, and purchased at a price which is not likely to result in a significant permanent loss of capital to the investor. Buying into stocks like Blumont, Asiasons or LionGold, which have scant business prospects and at way overvalued prices, is a sure-fire way for one to outlive that $1 million in the shortest possible time.

This article was originally published on DrWealth.


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