Market downturns can help target-date investors grow their retirement savings

It may seem counterintuitive, but in general, market downturns have shown to help target-date participants grow their retirement savings long term, primarily through:

• Participants being able to capitalize on falling stock prices—effectively buying more stock at lower prices
• By remaining invested in equity markets, participants gain access to the often-large early gains of an inevitable market upswing 

This points to a clear benefit for younger plan participants in the accumulation phase of saving for retirement, and it’s supported by data that shows that over the past 50 years or so, all but two market downturns recovered within two years.¹ But what happens if a participant is retiring soon and needs to plan for a market downturn?

The potential impact of a market downturn on new retirees

Participants are increasingly retaining a meaningful allocation to equities during retirement to mitigate the potential of longevity risk where they may outlive their retirement savings. As a result, higher allocations to risk assets broadly have become more commonplace over time.

For participants retiring into a downturn, the question is whether exposure to risk assets such as equities hurts or helps a portfolio and how market volatility may impact their retirement savings.

Let’s consider a participant retiring into the 2007–2009 global financial crisis as an example.

The following assumptions apply:

• By 2007, the participant has accumulated $1 million in retirement savings and continues to add contributions of $500 monthly until retirement
• The participant retires in December 2008 and doesn’t require an income for five years
• Equity exposure immediately prior to retirement is 60%, reducing to 50% at retirement, and gradually reducing over 10 years to stabilize at 25%

^{_{Source: Morningstar, Manulife Investment Management, 2022. For illustrative purposes only. Not reflective of any fund. Hypothetical portfolio is rebalanced monthly. There are no rebalancing fees. Retirement contributions occur at the beginning of the month. U.S. large-cap equity is represented by the S&P 500 Index, which tracks the performance of 500 of the largest publicly traded companies in the United States. U.S. mid-cap equity is represented by the Russell Midcap Index, which tracks the performance of approximately 800 publicly traded mid-cap companies in the United States. U.S. small-cap equity is represented by the Russell 2000 Index, which tracks the performance of 2,000 publicly traded small-cap companies in the United States. International equity is represented by the MSCI Europe, Australasia, and Far East (EAFE) Index, which tracks the performance of publicly traded large- and mid-cap stocks of companies in those regions. Emerging-market equity is represented by the FTSE Emerging Index, which is a free-float market-capitalization-weighted index that tracks the performance of the most liquid large- and mid-cap companies in the emerging markets. The Bloomberg U.S. Aggregate Bond Index tracks the performance of U.S. investment-grade bonds in government, asset-backed, and corporate debt markets. The Bloomberg U.S. Corporate High Yield Bond Index tracks the performance of the U.S. dollar-denominated, high-yield, fixed-rate corporate bond market. Emerging-market debt is represented by the Bloomberg Emerging Markets (EM) U.S. Dollar (USD) Aggregate Bond Index, which is a flagship hard currency EM debt benchmark that tracks USD-denominated debt from sovereign, quasi-sovereign, and corporate EM issuers. Alternatives are represented by the Wilshire Liquid Alternative Index, which tracks the performance of the five liquid alternative strategies that make up its universe. It is not possible to invest directly in an index. Past performance does not guarantee future results}.}

With $1 million in accumulated retirement savings and regular contributions of $500 per month until retirement, the participant’s portfolio reaches a maximum value of just under $1.1 million in October 2007 before the market downturn begins. This portfolio reaches its lowest point in February 2009, by which time it has lost 37.5% in value from its previous high. Retirement savings are now valued at $683,448. A loss of this magnitude would be alarming for any investor. By comparison, the S&P 500 Index fell 46.6% between October 2007 and March 2009.

As we often emphasize, selling financial assets into a downturn locks in losses, severely limiting a portfolio’s ability to fully participate in a recovery. However, we also recognize that behavioral biases driven by broad market sentiment at this point in a downturn are often so strong that their effects become pervasive, causing many investors to sell at the worst time. Hindsight in these instances is a useful reminder that every downturn in history has been followed by a recovery, and oftentimes sooner than markets anticipate. It also underpins the merits of being invested in a strategic and actively managed portfolio with a deliberate and robust glide path design.

In our example, it takes three years for the participant’s portfolio to recover to its previous maximum value of nearly $1.1 million. Within five years, the portfolio has not only recouped all losses, but also added growth of nearly 40% to reach just under $1.5 million in value.

Research shows that participants aren’t withdrawing an income immediately 

A comprehensive study from the National Bureau of Economic Research published in 2022 observes that a growing number of participants are reaching required minimum distribution age (between 70½ and 72, depending on birthdate) before starting to withdraw an income from their retirement savings.² This is significant as it could mean that three-quarters of participants aren’t initiating an income withdrawal immediately, but rather only within a six-year period of retiring. Reverting to our example, this may indicate that even participants retiring into a downturn may have the opportunity—and time—to recoup financial losses before needing to withdraw from their savings.

Naturally, every participant is different and individual outcomes will depend on individual circumstances. Moreover, it’s important to recognize that past performance does not guarantee future results. Notwithstanding this, a review of this period coupled with research showing that a majority of participants don’t need to withdraw an income immediately should be encouraging to financial professionals and participants alike facing volatile markets.

Weathering volatility with appropriate glide path design

Volatile markets test the nerve of every investor and it’s natural to want to change a portfolio’s asset allocation when surrounded by strong behavioral influences driven by negative market sentiment. However, based on research and our own analysis, participants within a strategic and actively managed glide path design should feel somewhat at ease knowing that their target-date portfolios and asset allocation are robust and poised to not only weather a downturn but to also be positioned for a recovery. 

1 Bloomberg, Manulife Investment Management, July 2022. Business cycles from 10/22/57 to 7/19/21 using the S&P 500 Index, which tracks the performance of 500 of the largest publicly traded companies in the United States. It is not possible to invest directly in an index. Past performance does not guarantee future results. 2 “Trends in retirement and retirement income choices by TIAA participants,” National Bureau of Economic Research, April 2022.