If you planned to retire in 2022, you’re probably second-guessing yourself right now. With markets turning bearish, rising interest rates, and high inflation, no one’s going to blame you for feeling a little queasy.
But does that mean you should wait another year to retire? Let’s go over the three headwinds that face soon-to-be retirees and how to approach planning for them. And be sure to read until the end where I’ll share my thoughts on how to tackle the question of retiring in 2022.
When it comes to bad financial news, rising inflation may be the most alarming topic that would affect your plans to retire in 2022. The Consumer Price Index (or CPI) stands at 8.3% at the time I’m writing this. You’ll have to go all the way back to January of 1982 to find a monthly CPI figure that high.
This level of inflation is sobering, given that inflation averaged 3.11% between 1913 and 2021. We’re seeing an extraordinary increase in the price of goods and services. On top of that, there’s plenty of disagreement on whether CPI is an accurate measure of inflation – many believe that the changes to the index that have been made over the years understate the real numbers.
Since the largest driver of your financial plan’s success comes from your everyday living expenses, higher inflation makes it that much more difficult for your investments to keep pace. Now would be a great time to revisit your financial plan and adjust your inflation assumptions if you haven’t already.
The U.S. has experienced periods of high inflation before, the “stagflation” era of the late 70s and early 80s being the most recent. Other periods of high inflation include World War I and World War II. It’s interesting to note that these high-inflationary periods were immediately followed by relatively low-inflationary periods. In fact, following World War I, the U.S. experienced a deflationary period for some time, which included the Great Depression.
For inflation, the takeaway is that, as you review your financial plan, it’s not reasonable to project our current CPI marker of 8.3% ad infinitum in your planning. Likely, if the cycles of history will repeat and there will be a period of lower inflation (or deflation) on the other side. You can stress-test your financial plan by increasing your inflation assumptions, but I wouldn’t go overboard.
Rising Interest Rates
If you plan to retire in 2022, rising interest rates are a double-edged sword. On one hand, higher interest rates will eventually make bond and cash investments more palatable again. Years of suppressed interest rates have forced investors to purchase riskier assets at higher prices because they believe “there is no alternative” at this point. The middle ground between high risk and safety has been stretched thin and rising rates would fix that.
Unfortunately, rising interest rates have a negative impact on the bonds you currently own. Bond values are inversely correlated with interest rates. Therefore, whenever rates go up, bond values go down. To protect yourself from this as much as possible, it’s important to review your bond portfolio’s duration and credit quality. The longer the bond, the greater its sensitivity to interest rates.
Until this year’s rate increases, interest rates have steadily declined ever since the mid-80s, giving bonds a nice tailwind for returns. It seems the winds have changed, and bond returns will likely be lower over the coming years. The question becomes: if markets tank, will the Fed abandon its rate hikes and come to the rescue? Or will it continue to fight high inflation by raising rates? Jerome Powell and company may find themselves in a pickle at some point soon.
For protecting against rising interest rates, it may make sense to re-run your financial plan assuming lower-than-historical bond returns. For the portfolio itself, ask your financial advisor about your bond portfolio’s duration and how it would react in a rising interest rate environment.
As if rising inflation and interest rates aren’t enough, we’ve seen some significant market declines so far this year. If you were planning to retire in 2022, this must be the most alarming development so far. At the time of writing this, the S&P 500 is down over 18% year-to-date, close to a “bear market” drop of 20% or more.
There’s also talk of an economic recession. We’ve already had one quarter of negative GDP growth in 2022 – if there’s a contraction in second quarter, we would officially be in a recession.
Of course, markets go up and down. Sequence risk – the risk of experiencing bad returns at the beginning of your retirement – is typically associated with the stock market and included in most financial plans. That doesn’t make the experience any less uncomfortable, but most financial plans will account for this.
By several measures, markets are still overvalued, so there is the possibility of further downside when it comes to stocks. While nobody knows exactly what markets will do over the remainder of 2022, I would not be surprised if there’s still another leg down. Not only is the demand side of the economy going to be challenged with rising prices and increased interest rates, but we’re also still dealing with supply-side issues with commodities and supply chains.
For stock market contractions, the best course of action is to re-run your financial plan assuming lower-than-historical stock returns in the initial years of your retirement. Many software programs used by financial planners have this capability. In fact, one program I use can replicate what your retirement would look like if there’s another Great Financial Crisis in the first years of your retirement. This is another great way to stress-test your plan.
Should You Retire in 2022?
If you planned to retire in 2022, I wouldn’t give up on it just yet. Yes, this year has started on a sour note. However, that doesn’t mean that the next thirty years of your retirement will be exactly like this one.
Sequence risk could certainly come into play for new and soon-to-be retirees – not just for stocks, but for bonds and inflation as well. While this isn’t an ideal scenario by any means, it doesn’t mean you can’t make it work.
Any good financial planner can adjust your financial plan to account for these variables and see how they affect your probability of retirement success. If, after stress-testing your plan, you find that there’s an uncomfortable chance that you’ll run out of money, then, of course, delay retirement.
However, you may find that, while high initial inflation and low returns may lower your odds a bit, you’re still in a strong financial position. If that’s the case, then you can sleep well knowing that the financial turmoil we’re experiencing today is built into your plan. You may also find that you’re able to lower your overall investment risk while still maintaining a high probability of retirement success.
What do you think? Are you planning to delay your retirement because of what’s happened so far in 2022? Or are you still planning for retirement?
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