THE PAST IS PROLOGUE

The bear has arrived with the S&P 500 declining 16.5% in Q2 and falling 20% through the first six months of 2022. The usual solace provided by the bond market was absent as the Bloomberg Aggregate Bond Index fell 4.7% in Q2 and just over 10% for the first two quarters of the year.

This was only the second time in the past 40 years that both stocks and bonds declined for consecutive quarters. The last time there was such an occurrence was during the Great Recession in 2008. Before that, it was 1981.

Concerns over inflation (up 9.1% the past 12 months) and interest rates (the Fed has raised rates three times this year), and their resulting effect on corporate earnings dominated the first half of 2022 and will continue to do so for the remainder of the year.

THE FED

An often-cited trigger for falling stock prices is Fed policy. Fed Chair Jerome Powell has publicly stated that his biggest concern is bringing down inflation, and the Fed’s policy tool is to aggressively raise the fed funds rate. A higher fed funds rate drives up short-term interest rates, which in turn reduces liquidity in the economy, depressing corporate investment and consumer borrowing. With inflation outpacing wage increases, consumer confidence fell for the 2nd consecutive month.

This is certain to dampen consumer spending, which accounts for nearly 70% of US GDP.

All of this is a reversal of a long-term trend where Fed policies provided a fairly strong wind at the back of the investment markets. Bond rates are going up and liquidity is going down, the reverse of the conditions that began with the economic bailout

of the Great Recession and accelerated with the stimulus packages following the Covid outbreak. In essence, the Fed is ‘taking away the punchbowl,’ which had been the impetus for low-interest rates and economic growth. The economy is now moving from a low-yield, low-inflation environment to one of higher inflation and higher interest rates.

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3838 Camino del Rio North
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619.255.9554

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However, not all inverted yield curves have resulted in recessions. The odds are greatly enhanced though that a recession will occur. There have been thirteen Fed tightening cycles since WW II, and only three times have they resulted in soft landings. A couple of positive signs indicate a recession is not on the immediate horizon. First, we continue to have very low unemployment numbers, currently 3.6%. Second, the May jobs report showed payrolls increasing by 372,000, the seventeenth consecutive month of positive job growth.

WHAT IT MEANS FOR PORTFOLIOS

On the equity side, we continue to re-balance and tax-loss harvest. When doing so we are adding to large-cap value and small-cap value and decreasing large growth positions. For fixed income portfolio allocations, we continue to reduce the durations and average maturities and re-allocate to short-term CDs and Treasuries.

WE ARE HERE FOR YOU

The Platt Wealth Management team is here for you to discuss any changes to your financial situation or investment objectives. We are always available to assist you with any financial matters of concern to you and look forward to continuing to serve as your partner along your financial journey.

Warmest regards,
Platt Wealth Management

How Market Cycles Can Impact Retirement

Markets go up. Markets go down. But no one can predict when, how, why, or for how long. Ups and downs are par for the investing course, but market cycles can have a greater impact on those nearing or in retirement than those in their accumulation years. That’s because in retirement you simply have less time and fewer opportunities to rebuild your savings should the market take a turn for the worst.

So, in order to understand how market cycles can impact your retirement (and what you can do about it) let’s look at some facts.

Understanding the Impact of Market Cycles

The most noticeable impact market cycles can have on your retirement is in regard to income distribution. When you rely on your investments to generate income, a less than favorable market cycle can dictate how long your money will last. That’s why it’s imperative to determine the optimal spend down of your assets, which can be complex and based on many factors (both known and unknown).

Over the years, many financial advisors have been applying the “4 percent rule,” developed several decades ago by financial planner William Bengen. Bengen modeled various asset allocations and spend down rates over a 30-year period to see how each would have fared. He found that, between 1926 and 1976, an asset allocation mix of 50 percent stocks and 50 percent bonds enabled retirees to safely draw down four percent of their assets annually without running out of money.

Following that rule in the 1980s and 1990s made sense because bonds and stocks experienced primarily positive returns. It didn’t work quite as well in the 2000s with a largely stagnated stock market, forcing retirees to deplete their assets more quickly.

What complicates this rule of thumb is market volatility, which introduces a greater risk to the portfolio. When retirees are drawing down assets during a declining market period, there is a higher probability their assets will not last as long as they’d hoped. The only remedy then seems to be to reduce the spend down rate, live a diminished lifestyle, or risk depleting their assets too soon. And of course, no one wants to run out of money.

There is even greater risk when the market declines at the beginning of retirement. A steep market decline in the first few years before or after retirement, even if followed by a sustained market increase, can severely impact future income. This risk is referred to as “sequence of returns” or sequence risk and is one that very few DIY investors are privy to. And if they are aware of the risk, they tend not to know how to account for it in their financial plans.

The Greatest Risk Retirees Face: Sequence of Returns Risk

When it comes to retirement drawdown and market cycles, timing is everything. That’s because sequence of returns risk stems from the timing of market returns and their impact on your portfolio when you begin to draw down your assets.

While it is fair to assume that the market will generate an average rate of return over time, that doesn’t account for the timing of those returns. Your portfolio can average eight percent a year over twenty years, but if the first three to five years consist of negative returns, it could be too much to overcome even if the next fifteen years produced positive returns.

Why? Because loss and gain are not inversely proportional. If stocks in your portfolio decline in value, you need to sell more shares to meet your income needs. That reduces the number of shares left to grow inside your portfolio. During a prolonged market decline, that accelerated depletion of shares could make it difficult for your portfolio value to recover as the market recovers.

Imagine your portfolio like an apple tree. Each year you need to take 40 apples from the tree to survive. Based on the tree’s history, this is a safe rate at which the tree will at least replenish if not surpass restoring those 40 apples. But, if when you begin taking those 40 apples out each year, the tree starts to produce fewer apples—you run the risk of using up all your apples before the tree has a change to grow more.

Our Contact Information

3838 Camino del Rio North
Suite 365
San Diego, CA 92108
619.255.9554

info@plattwm.com

www.plattwm.com

Consider the following chart showing two portfolios starting with $500,000. Both are drawing down assets at a rate of $25,000 per year adjusted for 3% inflation. Portfolio 1 experiences negative returns in the first three years, followed by multiple cycles of positive and negative years. Portfolio 2 starts out with four years of double-digit returns followed by a typical market pattern of positive and negative returns with three years of negative returns at the end.

For this analysis, the same rates of returns are used in both portfolios, except their sequence is reversed. So, both portfolios generated the same 6.5% average rate of return, yet the outcomes were vastly different due to the sequence of returns.

Key Takeaway

While you can’t predict the stock market’s direction, much less the sequence of returns as you enter retirement, you can prepare a diversified portfolio that is designed to handle such possibilities. We help our clients mitigate this risk and provide them with peace of mind that the retirement income plan we have built for them will be able to mitigate the sequence of return risk and boost their overall lifetime income sufficiency.

For a Moderate portfolio (60% stock/40% bond allocation) and an Aggressive portfolio (80% stock/20% bond allocation), the probability of a loss over 5-year rolling periods was 0% (same for the Conservative portfolio with a 30% stock/70% bond allocation). There was an 18% chance of a loss over one year for the Moderate and Aggressive portfolios, but usually that loss is less than 10%. The odds are pretty good that over the next 5-years, these portfolios will have positive results, and there is even more than an 80% chance that they will have positive results over the next 12-months. See illustration from Morningstar 2021 below.

WE ARE HERE FOR YOU

The Platt Wealth Management team is here for you to discuss any changes to your financial situation or investment objectives. We are always available to assist you with any financial matters of concern to you and look forward to continuing to serve as your partner along your financial journey.

Warmest regards,
Platt Wealth Management

2021 AT A GLANCE

Entering 2021, investors faced a backdrop of uncertainty, and there were many reasons to be pessimistic about the markets. In modern history, restoring a world economy from an abrupt halt was unprecedented, and COVID-19 continued to impact business activity. Despite that, markets demonstrated strong performance, the unemployment rate fell to 3.9% in December, and S&P earnings grew by 34.5%. More than any other, the past year demonstrated the importance of staying disciplined despite all the “noise.”

2022: STRONG BUT SLOWING GROWTH

Economic activity has surpassed its pre-pandemic levels and consumer financials, in aggregate, appear healthy. Vanguard’s Economic and Market Outlook for 2022 anticipates GDP growth of 4%. However, some factors pose risks to the strong recovery and normalization of the economy. Bottlenecks in the supply chain and labor and materials shortages have pushed prices higher, and there is uncertainty around when these issues will subside. Overall, supply and demand imbalances continue to persist.

The U.S. labor force is unlikely to return to pre-COVID levels as retirements and unanticipated retirements totaled two million as of June 2021.

Going forward, it is expected that the U.S economy will experience strong growth but at a decelerating pace. The consensus is also that inflation will persist in the 1st half of 2022. Concerns are whether the Fed can keep inflation in check without stalling the economy, if supply chain issues can be resolved and if higher interest rates will result in 1970’s stagflation (stagflation occurs when inflation is high and the economy slows, leading toward higher unemployment).

MONETARY POLICY AND THE FEDERAL RESERVE

The Fed has remained extremely accommodative in its stance towards the economy, despite the strength of the recovery, inflation pressures, and low unemployment rates. However, recent statements from Chairman Powel indicated that the era of “easy policy” may be coming to an end as unemployment levels tick lower, and the focus shifts to combatting inflation. The Fed’s extraordinary bond purchases are expected to end late Q1 or sometime in Q2. Additionally, it is anticipated that there will be as many as three rate hikes in 2022.

Our Contact Information

3838 Camino del Rio North
Suite 365
San Diego, CA 92108
619.255.9554

info@plattwm.com

www.plattwm.com

The Platt Wealth Management team is here for you to discuss any changes to your financial situation or investment objectives. We are always available to assist you with any financial matters of concern to you. We look forward to continuing to serve as your partner along your financial journey.

Warmest regards,
Platt Wealth Management