Retirement savers are cautioned not to change investment strategies during market volatility, but it can be tempting when the value of your investments is falling before your eyes and you rely on that money.
Often times, retirees shouldn’t change their strategies too much when the market first starts acting up. If you’ve got a thoughtful financial plan and a diversified investment portfolio, the general rule is to leave everything alone. But investing is emotional, which means people sometimes feel the need to do something. Retirees may be especially stressed by market volatility, since they are no longer working and need the money they’ve accumulated to last them the next few decades.
A third of Americans in a Kiplinger poll of 850 preretirees said they’d reduce investments in stocks if they were faced with market volatility during retirement, this came right after cutting back on spending (which was 41% of respondents).
They said they’d also reduce stock investments in portfolios before retirement: 40% said they’d trim their holdings 25% or less, while 28% said they’d lower their stock investments 50% or less. Respondents said they’d opt for other savings vehicles: 53% said they have or would increase contributions in their savings accounts, 39% said they’d do so in money market accounts and 34% said they’d increase certificates of deposits (some also mentioned annuities, U.S. Treasurys and gold).
Retirees entering retirement at the start of a downturn are most in danger of facing the “sequence of returns risk,” where they are withdrawing from their portfolios’ principles because the investment gains are minimal (or nonexistent). Taking money that’s coming out of the principle diminishes potential returns in the future.
The key to successfully riding out stock market volatility or a downturn in retirement is to plan for it ahead of time. Some advisers will allocate a few years of client income in bonds, for example. Daniel Lash, a financial adviser and partner at VLP Financial Advisors in Vienna, Va., suggests stashing five to seven years of client income into bonds, because that’s how long it took stocks to recover from the last two big market downturns. “During those years that stocks are down or recovering, the bonds are sold to create income needs,” he said. “In this way, you are selling investments that are up or down the least to provide income to the client.”
Diversifying the types of accounts used in retirement is also helpful to avoid realized portfolio losses. Retirees should aim to have numerous types of investment accounts, such as money from tax-deferred accounts (like a 401(k) plan), Roth accounts (which are funded with after-tax dollars) and taxable brokerage accounts. The ability to choose which account to withdraw from can mitigate negative tax consequences.
Advisers also suggest having a few different sources of income, said Dennis Nolte, a financial adviser at Seacoast Bank in Oviedo, Fla. Investors may want to create a few investment accounts that are allocated for different time frames (such as one for the next 5 to 10 years, another for 11 to 20 years away, and so on). Other streams include tapping into home equity and receiving Social Security.
A cash “emergency fund” can also lower the risk of withdrawing from an investment portfolio during a downturn too soon, said Margaret Doviak, an adviser and owner of DM Wealth Management in Norman, Okla. The amount to have in that account can be between six months and two years worth of monthly distributions, and it can be held in a “safer” vehicle, like a money market account. “This strategy allows the market to recover without needing to sell investments while they are depressed,” she said.
Just as preretirees are told, retirees shouldn’t make drastic changes to their retirement portfolios during market volatility or a downturn. “Once in retirement, you need to execute the plan you have in place when you retire,” said Kent Fisher, senior wealth manager and founder of Southern Investment Management Collective in Chapel Hill, N.C. “You just need to be sure you thought about these issues in advance and execute on your plan.”
