The stock market has been quite volatile in 2016 which is great for long term investors because you can buy stocks at a discount. If you have five or more years left before retirement, then you should continue to invest regularly and not worry about stock market gyrations. Dollar cost averaging works very well when the market is up and down. However, a volatile market is really bad news for one particular group of people — those who just retired or will be retiring soon.
A few years of negative returns right after retirement can do irreparable damage to your nest egg. Retirees typically need to sell their investments to pay for their expenses. Retiring while the stock market is down means you would have to sell at the worst time, and it’s tough to come back from that initial setback. The first five years are the most crucial in setting the stage for the rest of your retirement. After the first five years, a volatile market would still be painful, but it wouldn’t impact your retirement as much.
The easiest way to avoid the risk of depleting your portfolio early is to work a few more years until the stock market recovers. Historically, a bear market occurs about once every 3.5 years and lasts around 15 months, according to CNBC. If you can continue working until the market recovers, then your portfolio will hold up much better throughout your retirement. Of course, working longer is not always an option. If you can’t put off retirement for a few years, then you need to be prepared for the worst case scenario. Here are three tips for retiring in a volatile market.
1. Build a Cash Cushion
Cash is king in a volatile market. Astute investors with cash can take advantage of opportunities that arise when other investors are nervous. Cash is especially important to retirees because it means you don’t have to sell stocks at the bottom.
Retirees should keep enough cash to fund one to two years of living expenses. That’s including social security and any other income you have in retirement. So if you spend $50,000 per year and receive $20,000 in social security benefits, then you would need to keep at least $30,000 in cash. That cash cushion will pay for one year of living expenses and help get you through the worst of the bear market. Two years of living expenses would be much safer in the current environment, however.
2. Adjust Your Asset Allocation
If it has been more than five years since you reviewed your target asset allocations, you should go over them. Most people don’t like risk as they get closer to retirement. It’s great to have more equity when you’re young, but as you approach retirement, you need to be a little more conservative. Young people can handle a 90 percent stock allocation because they have a very long investment timeline and big stock market drops are great for them. They can keep investing and benefit when the market recovers. Retirees, however, have to live off their portfolio and will be hurt more if they have too much equity. Retirees can’t be too conservative either. They will need the growth from stocks to help fuel their 20 years or more of retirement.
In general, soon to be retirees should have at least 40 percent in bonds. Bond prices typically increase when stocks are falling. They will provide a moderating influence when the market is volatile. Your portfolio will drop less than the market indexes when you have some bonds in your portfolio. Investors can also dip into bonds to pay their expenses if the bear market lasts longer than expected. This could throw your asset allocation out of whack, but it’s easy to rebalance after the stock market recovers.
3. Reduce Withdrawal Rate
Another way to preserve your investment portfolio during volatile times is to reduce your withdrawal rate. Nobody likes this option because it means a change in lifestyle. Usually, a withdrawal rate of 4 percent will enable your portfolio to last 30 years in retirement. However, it’s much safer to reduce the withdrawal rate to 3 percent if there is a big correction during the first five years of retirement. This will reduce the impact of a bear market to your portfolio over the long haul.
Cutting back can be difficult, but it’s not impossible especially if you retired recently. There are quite a few options, so here are some ways to temporarily reduce your withdrawal rate.
- Put off large expenses until the stock market recovers. Delay those expensive home remodeling projects for a few years. Visit South America instead of Europe for a while. Put off buying a new car and keep fixing your old car. Once the stock market recovers, you can splurge a bit to make up for putting things off.
- Earn some income. A little earned income goes a long way in retirement — even $1,000 per month can make a big difference. Recent retirees can consult or work part time for a few years. Some part-time income can really help your portfolio get through those crucial first five years of retirement.
- Put off retirement until after the bear market. I hate to say this again, but putting off retirement until the bear market is over is a very good option. You can keep investing and buy more at a bargain price. I know this is not an option for some people, but it’s a good idea if you can put off retirement for a year or two until the stock market stabilizes.
- Move to a cheaper location for a few years. I think this is a great option for someone who recently retired. I would love to take a few years off and go live in Thailand or Ecuador. You can live very well on less in many locations around the globe. The cost of living within the U.S. also varies widely. It’s much cheaper to live in South Carolina than San Francisco, for example. Relocating to a cheaper location is a great way to cut expenses and explore other parts of the world.
It’s no fun to cut back, but we only need to be extra vigilant over the first five years of retirement. Once that crucial period is over, you can go back to normal.
Stay the Course
The first five years are the most crucial years of your retirement. The stock market has been doing very well since 2009 and many investors feel we are due for a bear market. The global economy is very volatile and big drops like we saw after the Brexit decision could become more common.
This is a scary time to retire. Most of us still need some stocks to fuel our retirement portfolio so selling everything is not a good option. Retirees should prepare to weather a volatile market instead. Building a big cash cushion, making sure your asset allocation is appropriate and preparing to reduce your withdrawal rate are the three things that will help you get through this tough period.