Could you retire if the Global Financial Crisis happened again?
With stocks tanking recently this summer along with rumours of another recession looming thanks to our existing housing crisis in Canada coupled with higher interest rates – we think this is a legitimate question to ask.
You might recall The Global Financial Crisis (GFC) turned a few retirement dreams into investing nightmares. Stocks plunged in value during this period and evaporated the retirement savings of many, that took decades to build. This crisis further exacerbated other looming financial problems: there were plummeting home values at the time, stagnating wages, and the crisis triggered a decade+ era of essentially free money (rock-bottom interest rates) that also proved devastating for savers in general.
My how things like interest rates – change.
Many retirees and near-retirees felt the effects of the GFC for many years to come.
So we wondered here for today’s case study:
Could you retire if the Global Financial Crisis happened again?
Let’s find out…
Could you retire if The Global Financial (GFC) crisis happened again?
Pandemic impacts and outcomes aside, world markets have largely recovered since the GFC but make no mistake: this crisis was the worst U.S. economic disaster since the Great Depression.
According to a recent Washington Post article we read, the U.S. stock market lost nearly $8 trillion in value between late 2007 and 2009. Unemployment also spiked during this period, peaking at 10% in October 2009. Americans lost nearly $10 trillion in wealth as their home values plummeted along with retirement savings. It was a very, very trying time.
Triggers to the GFC started well before late-2007.
Back in 2006, U.S. housing prices started to fall for the first time in decades. At first, this was considered a great thing. But, those lower prices triggered excessive greed and fraudulent activity. Subprime mortgages were offered and granted to borrowers with poor credit histories. With the housing boom in the U.S. in particular, starting in the early 2000s, mortgage lenders sought to capitalize on rising home prices such that financial institutions started to acquire thousands upon thousands of risky mortgages in bulk (typically in the form of mortgage-backed securities) as an investment, in hopes of a quick profit.
We also witnessed rating agencies (that were paid by issuers) giving out flawed credit ratings. (This presented a conflict of interest as rating agencies had a financial incentive to overlook the true risk a security carried.)
We also observed financial institutions selling securities to investors that they knew to be incredibly risky. In some cases, banks were short selling the same securities they were promoting to fund managers. We also watched institutions creating and selling synthetic financial products to help hedge funds bet against the mortgage market.
You also might recall one of the big catalysts for the crisis was Lehman Brothers, which filed for bankruptcy when it could not be bailed out. One of the factors that contributed to the demise of this bank was a very dubious method of valuing repurchase agreements on its balance sheet. A loophole in the accounting standard allowed them to use repurchase agreements to hide the true extent of their greed – buying assets through leverage and debt.
Needless to say, this 2007-2009 investing period was a HUGE financial mess fueled by greed. Some folks regard the GFC as a black swan event. But anyone who is a student of market history knows that excessive greed by institutions or individuals will trigger bad market stuff again.
(You can read more about the accurate history and timeline of the GFC on History here.)
Sequence of Returns Risk
As a student of investing, you also realize by now the GFC wasn’t the only incidence when the stock market corrects or crashes or simply makes some people far less wealthy than they were before.
Source: Covenant Wealth Advisors U.S.
Although folks use stock market corrections or crashes terminology interchangeably, these are not the same things in our opinion.
A stock market correction – there is no standard, universal definition but let’s just agree this is a significant drop in any market index value of at least 10%. When it comes to the overall market, we’re talking about a decline of 10% (or more) that could last anywhere from days to months, or even longer depending on the circumstances. Typically, a correction is a drop of more than 10% but less than 20%. A reminder these things are called a “correction” because historically the drop often “corrects” and returns prices to their longer-term trend.
- A stock market crash – is typically a decline of more than 20%, usually in a very short period of time.
The good news from this: corrections occur more frequently than crashes and should be expected.
Just about every year since 1980, the U.S. stock market has experienced a temporary decline of 5% or more. Our market history is Canada is similar.
Here are the U.S. market returns year-by-year as measured by the S&P 500 index going way back:
Source: @CharlieBilello
Given our Canadian economy is tied directly to the American economy, and likely always will be, given so much of Canada’s GDP comes from exports to the United States, we should be mindful that over long investing periods Canadian stocks will (generally speaking) follow the returns of the U.S. stock market, although given the scale of our economy and assets we might lag in terms of total returns as well.
What is the potential impact to Sequence of Returns Risk?
With some high-level market history on the GFC and stock market returns out of the way, it’s therefore essential to recognize and accept as a long-term investor: corrections and crashes are effectively “normal” so best plan, prepare and be ready to work through them – including prior to and during retirement.
In fact, like we referenced above, 5-10% market corrections are VERY normal.
Since 1946 until about 2019 (pre-pandemic), there were about 84 declines of 5% to 10% over that period.
Our quick math says that works out to a 5-10% negative stock market change more than once per year.
Deeper declines have happened as we have referenced above in Charlie’s chart, but they occur less frequently. When markets do recover it takes many months to recover…
DECLINES IN THE S&P 500 SINCE 1946
| DECLINE | # OF DECLINES | AVERAGE TIME TO RECOVER IN MONTHS |
|---|---|---|
| 5%-10% | 84 | 1 |
| 10%-20% | 29 | 4 |
| 20%-40% | 9 | 14 |
| 40%+ | 3 | 58 |
Yet a another way to slice-and-dice market declines is to look at the positive:
When dividends (yes, dividends!) are factored in, the S&P has risen 72% of the time year-over-year since 1926.
While we’re off to strong start in 2023, especially for the U.S. market, a big reminder that markets can change in a hurry.
That’s investing.
Stocks should rise over long investing periods but it’s worth reminding all of us that any string of poor, negative, market returns at the wrong time can be devasting to your portfolio value/wealth. We also don’t know exactly how long the next set of poor market returns could be although the table above provides a bit of a history lesson.
All this say, we want to help you prepare for all of this.
In a previous post on our site, we discussed some very important ways all DIY investors can manage sequence of returns risk.
Consider this:
Versus this:
Source: https://www.blackrock.com/us/individual/literature/investor-education/sequence-of-returns-one-pager-va-us.pdf
Our takeaway to you from this BlackRock paper and various screenshots is you should consider your asset allocation (your mix of stocks, bonds, cash) to help you manage and survive a poor sequence of returns.
History can rhyme. Something like the GFC could happen, again.
Let’s see how we could prepare for it…
Our Case Study – Could you retire if The Global Financial crisis happened again?
For our scenario, we used the following assumptions for a single person to retire, right now not knowing what the returns will be this year and into the following years. Using our nifty projections software, by varying their asset allocation, how much does it impact the maximum they can spend if they retired at the beginning of the financial crisis? Let’s take a look!
- Current age: 65
- Final year age: 95
- Inflation at 3% and sustained for the next few decades
- No debt entering retirement (smart!)
- Only 50% CPP benefits at age 65.
- Full/max OAS benefits taken at age 65.
- Home Value: $500k
- RRSP/LIRA Balance: $800k
- TFSA Balance: $100k
- Province: Ontario
100% Equities: Max Spend: $44,000/year after-tax until age 95.
Chart of financial assets over time (blue invested assets, green real estate assets):
80% Equities, 20% Fixed Income: Max Spend: $48,500/year after-tax until age 95.
Chart of financial assets over time (blue invested assets, green real estate assets):
60% Equities, 40% Fixed Income: Max Spend: $49,800/year after-tax until age 95.
Chart of financial assets over time (blue invested assets, green real estate assets):
Could you retire if The Global Financial crisis happened again summary
As you can see from the charts above, the punchline is:
having some fixed income in your portfolio during retirement can help increase your spending ability by reducing your sequence of return risk.
This is especially true is the GFC happened again.
While having some fixed income is a good passive defense against market declines during retirement, another proven, albeit more active strategy is to have variable spending throughout retirement where you spend a little less during bear markets and perhaps a little more during years of higher return.
Looking for help?
If you’ve already been investing for some time, and want to know if you’re on track to meet any long-term goals including semi-retirement or retirement, we’re here to help.
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Knowing how to save and invest wisely for retirement is just part of the investment puzzle. In addition to that asset accumulation work, we believe all DIY investors should understand asset decumulation too – how to enjoy the money you’ve worked so hard to build in a tax-smart way as you manage your retirement portfolio.
Figuring out when to draw down your RRSP/RRIF assets, by how much, and when amongst other assets and accounts like TFSAs, your pension; when to take CPP or OAS and more is complex work.
We can help at a lower-cost.
We deliver personalized reports to help you make decisions and navigate your retirement income drawdown plans – it’s something we’ve helped dozens upon dozens of clients within the last few months alone!
If you are interested in obtaining private projections for your financial scenario, read more about our low-cost retirement projections services.
Thanks for your readership!
We look forward to sharing more detailed posts and financial wealth-building articles with you!
Mark and Joe.
Very interesting analysis – I feel a little less disappointed in my fixed income. Now I’m wondering at what point does the annual withdrawal amount start to reduce as the allocation to fixed income increases further! CAP, if you have the answer, I’d be interested to know.
Thanks Bob, again, not a HUGE difference in the analysis but bonds/fixed income do offer the real-life buffer when such events occur.
We would have to recheck the calculations but I suspect there is a small incremental benefit with 50/50 or even 60/40 bonds to stocks during such events but on the flipside, you wouldn’t be participating in any meaningful capital gains coming out of any major event either unless you could time the market – so there are always tradeoffs!
At the end of the day, we believe/continue to believe that a bias to stocks + cash/fixed income as part of a cash wedge per se is very smart as folks either enter retirement or remain in retirement to take advantage of growth after a market correction and/or survive it knowing most stock market corrections could last 12-18 months.
A reminder: “When dividends (yes, dividends!) are factored in, the S&P has risen 72% of the time year-over-year since 1926.”
That’s not bonds 🙂
CAP