Market volatility can negatively impact new retirees more than any other investor group. Let’s discuss ways to preserve your portfolio during the early distribution phase of retirement.
The Scenario
Picture this: You’ve worked hard all your life and successfully saved a sizeable nest egg. You’ve done the math and made your budget. All that’s left is to enjoy the retirement activities you have planned out. And then…the market takes a significant multi-year correction.
The dream of retirement can become the nightmare of not knowing if your money will last.
Market corrections affect retirees differently than those still working. While you’re working and saving, market dips present opportunities to buy at lower prices. In retirement, however, you’re regularly selling assets to generate income, so market downturns can directly reduce your expected income. Selling too much during a prolonged market slump can significantly disrupt your lifetime income strategy.
The Reality
I witnessed this first-hand during the 2000-2002 bear market, otherwise known as the dot-com bubble. Clients had seen their investment balances skyrocket in prior years and now they had “hit their number.” The retirement projections worked out wonderfully at these new high levels, and many did retire.
Then, over the next three years, the S&P 500 lost half its value. Previously wealthy professionals were now out of work, and their investment balances had dwindled. Many had to choose between a retirement that looked much different than anticipated or going back to work – if that was even an option.
An Example - The Sequence of Returns Risk:
Investor A and Investor B both retire at age 65 with $1,000,000 of after-tax funds. Both plan to take out $50k per year until age 90. Both investors face an investment environment that will generate 6% annualized returns over their 25-year investment horizon.
Investor A experiences market returns of 5%, 28%, and 22%, and -5% in the first four years of retirement. At age 90, the investor has $2,500,000 left to pass on to heirs.
Investor B experiences market returns of -25%, -14%, -10%, 16% (actual returns from 2000-2003) in the first four years of retirement. At age 82, this investor has completely depleted the portfolio.
Note: This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.
Minimizing the Sequence of Returns Risk
While we can’t predict or control markets, there are strategies that aim to minimize the sequence of returns risk. Consider these steps to help mitigate the risk:
- Bucket Approach – Allocate enough funds, perhaps 1-3 years’ worth of spending, to liquid, stable investments. This will prevent selling volatile assets in down markets.
- Flexible Spending – Plan some flexibility into your spending budget so you don’t have to take so much out during down market years. For example, maybe you don’t book that family trip to Italy until you’ve seen some positive performance from your portfolio.
- Defer Retirement – Either defer retirement by a couple of years so you have a larger cushion or consider working part-time for a few years to offset living expenses.
- Portfolio Preservation—Multiple methods aim to safeguard your portfolio against down moves. These are best addressed with your advisor.
- Tax Planning – You may want to consider converting IRA money into Roth IRAs before retirement. The Roths will serve as a source of tax-free income in your retirement years. This will also provide flexibility to manage your taxes more effectively from year to year. **
- Maximize Other Income Sources – Maximizing income from Social Security or pensions in the early years can allow more of your investment portfolio to remain intact.
- More Conservative Allocation – While you don’t want to get too conservative too soon, you also don’t want to go into retirement with an overly aggressive investment allocation.
Leading up to retirement, work with your advisor to stress-test your retirement plan. Planning for unexpected market volatility will allow you to enjoy your retirement more comfortably.
Compliance Notes:
**Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.**
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.
