I have friends who are thinking about retirement. Each has their reasons, but I imagine they may be wondering, “is this a good time to retire?”.
Some might think, ”anytime is a good time to retire (if I can)!” Others may be unsure.
In reality, it’s not a question that can be easily answered—certainly not as a general statement that would apply to all people unless it was something like, “sure, it’s a good time if it’s the right time for you.”
Some critical areas to consider are the current economic climate, your financial condition, and your loss tolerance and capacity.
In this article, I lay out a simple framework to decide if the time is right for you.
The current economic climate
As I finish this article in late July, the Fed just increased its benchmark interest rate by another 75 basis points (.75%), and the latest GDP number suggests the economy may be in the early stage of a recession. (The Fed would like to prevent it, but some say it’s inevitable.)
A combination of falling stock and bond prices, rising inflation, and the possibility of a recession present some serious challenges for most people who may be thinking about retiring in the next year or two. (It’s also hard on current retirees!)
No one wants to retire at the wrong time—and this may not be a great time to do it, at least from an economic perspective.
As I’ve written before, various factors have created high inflation and interest rates. Plus, a recession or stagflation could put further pressure on stock and bond valuations.
If there’s a silver lining, stock dividends have been relatively stable, and bond yields are going up. That will benefit those who want to retire and must rely heavily on their portfolio income to help fund their retirement. (It will also benefit current retirees eventually.)
Still another silver lining (how many silver linings can a cloud have, technically speaking?): Social Security benefits are higher due to adjustments for inflation. They went up 5.9% at the start of 2022, and that number for 2023 could be even higher (perhaps almost twice as high!).
Furthermore, as interest rates rise, new immediate and deferred income annuity payouts may also be higher. (If you have an older pension or fixed annuity that’s getting hit by inflation, you’re out of luck.)
What will happen to stock and bond prices in the future? No one knows for sure, and anyone who tells you they do is speculating. There are too many variables, and most are unknown, so we can never have certainty. Current market conditions make things even more challenging.
We all need a little perspective. Yes, things are very challenging, but they have been before. As we know, the past does not predict the future.
Take a look at this chart:
Stock Market Performance During Recessions – Last 50 Years
The longest recessions (shown in gray) since 1970 have lasted between a year and almost two. If we enter a recession, it may last longer or shorter, but a year to 18 mos. looks about average.
We don’t know if there will be a recession, a significant market crash, a short recovery, or a long recovery. A major crash followed by a prolonged recession would be very damaging, but that’s a worst-case scenario and not very likely, at least not historically speaking.
Your portfolio’s condition
Most people’s retirement portfolios are down from where they were six months or a year ago.
According to one source, a 60% stocks/40% bonds portfolio is down about 12% YTD. If that holds, it would be the sixth-worst annual return for a balanced portfolio over the past 100 years or so.
If you were approaching retirement and have had even greater losses due to an overly-aggressive portfolio, you may be thinking about shifting to a more conservative one to reduce further losses.
The problem is that the market could rebound from here (it’s up a little since its lows in June). Or, we could go get a recession, which could send stock prices even lower.
If you sell depreciated stocks only to see them go higher, that would be some unfortunate market timing. But not nearly as painful as the opposite, which is continuing to take too much risk and experiencing further losses which could prevent you from retiring when you want.
How can you decide?
For most people, the answer may be to do nothing. But if you were planning to retire soon, and further losses would prevent you from doing so, you may want to take action.
One way to think about this is to consider the worst-case scenario and do the opposite. For example, what would you feel worse about 1) Moving some of your stock allocations to bonds and then seeing the stock market rally, or 2) Leaving your portfolio positioned aggressively only to experience further market declines?
Another way to think about this is to imagine your entire retirement portfolio is sitting in cash and answer this question: How would you invest it if you had to invest it all right now?
You may also want to ask yourself: What would a prolonged recession, with possible losses of an additional ten, twenty, or even thirty percent or more, do to my portfolio? How would it affect my retirement plans?
Suppose you decide that you can’t emotionally handle an additional 10% total loss in your portfolio and think that a 25% decline in the stock market is possible. In that case, you shouldn’t hold more than 40% of your portfolio in stocks (25% of 40% is 10%).
While some portfolio changes are warranted under unique or extreme conditions, to do all this correctly, you have to time the market perfectly, and more than once. When is it time to get out, and when do you get back in? That’s extremely difficult to do.
If you want to retire soon, you may want to ‘de-risk’ your portfolio to a point where you are more comfortable with your risk level in terms of potential for loss. And if you shift to a more conservative allocation, you may want to stay there as you get closer to retirement, realizing that you may forfeit some potential gains in return for preserving your assets.
If you are younger and thinking about an earlier retirement, your ability to absorb losses is greater than someone in their 60s or 70s. That’s because you have time to make course corrections and recover from a prolonged down market if that should happen.
Someone older who wants to retire or is in the early years of retirement can’t afford too much of a loss because they have less time to recover. Plus, they may be spending from their savings while they’re declining in value (sequence of returns risk—more on that in my next article).
Your retirement readiness
The decision about when to retire is multi-faceted, but your financial condition is a critical part of that decision. You must determine if you can generate enough income to pay your bills, perhaps with a little extra for discretionary spending and generosity.
Your decision to retire means you’ll stop saving (possibly) and start spending your savings (probably). It also involves deciding when to start Social Security benefits and pension or annuity distributions if you have them.
In my book Redeeming Retirement, I introduce and apply something called the “Retirement Account Multiple” (RAM). Your RAM ‘score’ is a simple mathematical calculation: Your retirement savings are divided by your final income.
- RAM = Retirement Savings ÷ Final Income
- Final income = $100,000;
- Retirement savings = $900,000;
- RAM = $900,000 ÷ $100,000 = 9.
I also constructed a table based on RAM tables from several trusted sources. It shows a recommended RAM based on your age and your pre-retirement income:
Recommended RAM Score by Age
As you can see, a 67-year-old earning $100,000/yr and a RAM score of 9 is a little below the recommended RAM of 11 but possibly in the ballpark of having enough to retire, depending on expenses.
This table considers things like Social Security, a slight reduction in spending, a safe withdrawal rate of 4%, historical inflation, etc.
If you’re 67 and earning $100,000/yr and your savings have fallen from $900,000 to $720,000 (a 20% decline, which is about what the S&P 500 is off in 2022 YTD), your RAM score changes dramatically from 9 to 7.2, well below the suggested score of 11.
If you have a balanced portfolio, you may be down about 12%, which puts it at $792,000, yielding a RAM score of 7.9. Not too bad, but still well below the recommended score of 11.
Does this mean you can’t retire? No, not at all, but it may mean you need to make some adjustments.
For example, if you can keep working part-time, you can withdraw less and give your savings more time to rebound (as they inevitably will, but it’s impossible to know when or by how much).
You could also dramatically reduce your living expenses (by downsizing, for example, especially since home valuations and, therefore, home equity for many are at an all-time high). Doing so would reduce your income replacement ratio (IRR).
Your “income replacement ratio” (IRR) is another metric that can give you a reasonable estimate of your retirement readiness. It’s also a simple calculation and is the percentage of your pre-retirement income that you can replace in retirement based on your RAM and your savings withdrawal rate (SWR).
- IRR = RAM ÷ SWR
Here’s another table from my Redeeming Retirement book:
IRR by RAM and SWR
Let’s say you have a pre-retirement income of $100,000 a year and a RAM of 8. That means you have savings of $800,000. At an SWR of 4% (historically considered a “safe” withdrawal rate), your IRR is 32%:
- IRR = 8 ÷ 4% (.04) = 32%
This tells you that you’ve replaced 32% ($32,000) of your pre-retirement income.
As you see in the table, if you increase your SWR to 6%, you’ll replace 48%, and so on. (But remember, increasing your SWR beyond the ”safe” range of 3% to 5% increases the risk of early portfolio depletion.)
A 32% to 48% IRR alone will not be sufficient for most people. But the majority will also have Social Security and perhaps a pension or annuity. If you receive Social Security benefits of $36,000 per year, you’ll replace an additional 36% of your pre-retirement income, bringing your total IRR to 68% ($68,000) before taxes.
A recently published study by T Rowe Price of retirees three years into retirement found that they were ”living on 66% of their pre-retirement income on average,” and 57% reporting living as well or better than they did when working.
An editorial comment: Those percentages seem very low to me. But this is an “average” (meaning that the numbers could be heavily skewed toward either end). Such a low percentage suggests that a large number of respondents had a lot of discretionary spending before retirement as, for most people, a total IRR of 66% will only take care of the essentials, perhaps with a little to spare. If they downsized or reduced expenses in other areas, that could be a reasonable percentage.
Here’s another table (published by J.P. Morgan in 2020) also from my book that shows how this works at various income levels:
IRR Based on Pre-Retirement Income
The table suggests that those with lower pre-retirement incomes will need a higher IRR to retire, but those with higher incomes may be able to get by with a lower IRR if they have flexibility with their expenses.
For those in the T. Rowe Price study, the average income in retirement was around $118,000, which is on the high side. The table shows an average total IRR of 78%, suggesting that the 66% total IRR in the TRP study may be a little low.
Your plan for retirement
It’s not just about financial readiness. You need to think beyond that to what you plan to do in retirement.
Why do you want to retire? What’s your vision for retirement? If you can’t answer those questions, or lack God’s perspective on retirement, pray, study, and get wise counsel—make sure you know God’s heart in the matter before you make one of the most important decisions of your life.
If you need help or encouragement in this, I suggest my book, Reimagine Retirement: Planning and Living for the Glory of God.
Risk is real
The risk of retiring without a plan for how you’ll spend your time could be as great as your financial risks. If you’re not ready, no amount of retirement savings or income is going to make up for that.
In terms of the financial risks, a declining market can increase sequence risk early in retirement. However, retiring when stock market valuations are high carries risk too as future expected returns are diminished.
But due to the recent market downturn and the Fed’s aggressive quantitative tightening, stock valuations are down (though some would say they are historically high while others will disagree), and interest rates are rising.
Therefore, for those investing “new money” into stocks and bonds, expected returns may be higher than expected. But for those who want to retire and their savings have declined, it’s a different proposition.
When you retire, you’re trading your income from work for income from savings and other sources, such as Social Security. Is it risker to trade your work income for an income that may be less? Would it be better to work a little longer, invest a little more, wait for stocks to come back and bond funds to recycle, and let your Social Security benefits?
Only you can decide.
An alternate strategy, especially if you would like to leave your current job, is a ‘hybrid’ approach: a part-time retirement. You could find part-time work while delaying Social Security and minimizing withdrawals from retirement savings if you can.
If this sounds a little like “not retiring,” that’s because it is, but it may be a more flexible and enjoyable lifestyle that permits you to do other things. It may also help reduce sequence of returns risk.
There is only one thing sure about these decisions: the decision to retire—now or later—is not easy. Plus, there are no certainties—it involves making assumptions about think you cannot know for certain or control absolutely. Current economic and market conditions make it more difficult.
Math is math, but it doesn’t account for the changes that will occur or what you can do in response to them. Deciding to retire, especially during tumultuous times, will always carry some risk, which is why it’s essential to do your homework, seek wise counsel, and pray. Then once you have a direction, whether it’s to retire or work longer, move forward in faith.
Want to learn more?
Learn more about the approach to assess your retirement readiness I described in this article (and how to catch up if you discover you are behind) from my book, Redeeming Retirement, by clicking on the image below: