Gen X retirement portfolio risks rise as dotcom lesson returns

Gen X retirement portfolio concerns are rising as Americans born from 1965 to 1980 move closer to drawing income from savings rather than building them. Research from Alliance’s Retirement Income Institute says only 14% of Gen X workers have a traditional pension, compared with 56% of baby boomers, leaving many more dependent on 401(k) plans, IRAs and market returns.

That shift has increased the importance of timing. After a long period of gains, many investors approaching retirement have substantial exposure to S&P 500 mutual funds and exchange-traded funds, according to financial advisers cited by CNBC. A market decline shortly before or after retirement can do more damage than the same decline earlier in a career because investors may have to sell assets to fund living costs.

Why does the dotcom bubble matter for Gen X retirement portfolios?

The dotcom bust shows how long recoveries can take after a major equity drawdown. Amazon shares bought near their 1999 peak did not regain that level for roughly a decade, while the S&P 500 took nearly five years after its October 2002 low to set a new high in 2007, then fell again during the financial crisis and did not clear that 2007 peak for good until March 2013.

For an investor with several decades left to work, a long recovery can be absorbed through continued contributions and time in the market. For someone three to five years from retirement, the same recovery period can overlap with withdrawals, raising what advisers call sequence-of-returns risk.

Sequence-of-returns risk is the danger that poor market performance arrives early in retirement, when withdrawals are beginning. Ernie Cave, a certified financial planner and founder of Cave Wealth Management, told CNBC that retirees who sell depressed investments to generate income lose shares that would otherwise have participated in a later rebound.

How are advisers separating near-term cash needs from long-term growth?

Cave said the issue is not ownership of an S&P 500 fund itself, but relying on the same fund for bills due soon and for growth over a 25-year retirement. He said his firm typically seeks about two years of expected portfolio distributions in cash or very short-term investments, and about five years of expected withdrawals in cash, Treasurys, certificates of deposit and high-quality bonds, while leaving longer-term assets invested for growth.

Advisers also cited glide paths and bond tents as ways to reduce forced selling after a market decline. Elias Friedman, a certified financial planner and founder of Kadima Wealth, described a glide path as a gradual move from stocks toward bonds as retirement nears. He said a bond tent temporarily increases bond holdings in the years just before and after retirement, the period when a downturn can be especially damaging.

Friedman said investors have options such as bond or CD ladders and short- to intermediate-maturity securities, and that reallocations can be made gradually with portfolio rebalancing rather than through a single large change at retirement.

What role does S&P 500 concentration play?

Several advisers pointed to the concentration of the S&P 500 as a separate risk. Asher Rogovy, chief investment officer of registered investment adviser Magnifina, told CNBC that an estimated 40% to 50% of the index’s market value is tied to companies connected to artificial intelligence. He said concentration risk is built into capitalization-weighted indices and noted that equal-weighted S&P 500 exposure would have reduced some of the dotcom-era decline and recovered sooner.

Mike Dunlop, a certified financial planner and co-founder of Ignite Planning in Cedar Falls, Iowa, said seven companies now account for more than 30% of the S&P 500. He said the danger for investors aged 50 to 55 is a decline that coincides with retirement withdrawals. His firm has shifted some client assets from core S&P 500 or total-market index funds into large-cap value exposure, according to CNBC.

Advisers did not argue that near-retirees have no need for stocks. Their shared point was that retirement changes which dollars can be exposed to a full market cycle and which dollars may be needed soon for income.

This story draws on original reporting from CNBC.