Our grandparents used to have many children, as in a society where self-subsistence was prevailing, children would care for their parents in old age. Obviously, many things changed at a rapid pace, and today we save for our retirement ourselves, our children will travel the world while we smoke our pipe on the terrace. In a nutshell, instead of raising children and spending time and effort on a large family, we now have small families (often below the fertility rate), and we spend a lot of effort in balancing our budget to make sure we save enough for our retirement. That is at least what my mom told me to do!

My retirement savings in normal times

Of course I prefer to put my savings in a growing investment portfolio, with a yield larger than a simple bank account. Inflation would eat up my purchasing power at retirement, I therefore need to do better than the Treasury bonds. Additionally, since I am quite young and I have a long time horizon when looking at my retirement portfolio, my adviser told me I can invest in higher yielding financial products. Obviously the risk involved is larger than with low yielding products, but since my retirement was far away (I was 29 at the time), I could absorb shocks. Well guess what, I am not too sure that adviser made any simulation in his life.

Hereunder you will find a simulation made (by myself) looking at long term investments and retirement. The graph shows a pretty healthy outcome, with a wealth of more than $1.2 million at the age of 85, enough to make sure that I have a buffer in case I live longer…

Then came Lehman Brothers

The time is right to talk about market crashes, we’ve seen one of the worst weeks since more than 20 years, and everybody is comparing this crisis with 1929. Personally I do not think this crisis will be as long lasting as the Great Depression, but you never know. Anyway, if I look at what the impact is of a market crash on my long term perspective, it is quite gloomy. With a portfolio expected to perform with an annual average growth of 7%, the current market crash destroying more than 40% of the value of the S&P 500 index, the impact on my portfolio is smaller, for the moment I am at a 25% loss. On a small portfolio like mine, 25% loss is not such a big loss, however, if we look at the next figure, we see that the value of my portfolio at the age of 85 is down to $800,000 …. A loss of $400,000!!

Of course the 7% portfolio performance is supposed to be an average taking into account times of very good performance and times of bad performance. However, I do not think this kind of market crashes should be taken up lightly. The huge amount of losses that we have seen recently do have an important impact. As an example, a portfolio that loses 25% has to go up by 33% to be at its original level! I therefore find it sound to look at the impact of extra-ordinary crashes, to make sure my portfolio is stress-tested (although too late since the crash is already taking place).

The calm after the storm?

As seen in Figure 2, a sound average growth rate of 7% will provide me with a sound portfolio at retirement, although I lost $400,000 on what I expected. Here is what my financial adviser will tell me next time I see him: you invest on a long term horizon, everything will average out to make optimal use of dollar cost averaging. Well yeah, but when was the last time we had a big crash like this? The last big crash everybody still talks about took place in 1987, that is only 21 years ago! What if a new big crash takes place in 20 years from now?

The next figure shows you what a terrible impact it would have… I lost a $1.2 million buffer at the age of 85