The stock market has driven investors crazy over the past few months. It’s during these turbulent times that I get more calls from individuals worried about their retirement assets and wondering what they should do. The callers I care most about are those preparing for retirement. The memory of the 2008 financial crisis and the turbulent pandemic recession of 2020 is still fresh in many people’s minds, and now that inflation is rampant, many are asking, “What if I retire in a bear market?” Here are three different ones There are strategies for you to consider that will allow you to still retire when you want to, without market volatility (or downturn) affecting your plans or causing you to run out of money sooner than you initially thought:
Strategy #1: Bucket Strategy
How this works: In some jargon, this is also known as a time-based segmentation method. Using this strategy, you divide your funds into 3 hypothetical buckets that align with your spending needs and the timeline of those needs. E.g:
Bucket 1 (short term): This is the amount of money you expect to be withdrawn over the next 3 to 5 years. Most people would put the bucket in cash or very conservative investments. The idea is that the money is protected from market downturns, while the rest of your investments can have time to recover before you need to start withdrawing them (aka as the market grows).
Bucket 2 (mid-term): This bucket is the money you might need in 5 to 10 years. Most people would invest that bucket in mid- to long-term fixed-income assets like bonds or bond funds.
Bucket 3 (long term): This is basically your leftover money that you estimate you won’t need to withdraw for 10 years or more, so you want to keep growing. You will typically use stocks (aka stocks) as this bucket because you will have time for the money to recover from any prolonged bear market and ideally continue to grow for a few years.
shortcoming: It’s often hard to trust the process and not let emotions get in the way. During a rising market, you may feel that the cash you set aside isn’t working hard enough and that you should take more risk. Likewise, during a market downturn, you may start to feel anxious and should move your funds to cash just to be safe. Both of these reactions can hurt you because it’s nearly impossible to consistently time the market in the long run.
What to watch out for: Managing your money in different account types such as tax-free (Roth), taxable (brokerage account) and tax-deferred account (IRA/401k) can be challenging. Ideally, you may want to adjust your investments to the correct account type for maximum tax benefits. (For example, higher growth investments/high income investments might go into a Roth account so you can get tax-free growth without worrying about capital gains tax/income tax, while municipal bonds earning tax-free interest make more sense in a taxable account .)
what can make it work better: Sticking to your plan and developing a strategy to replenish and reallocate your buckets, while being mindful of the type of account your assets are invested in is key to the success of this strategy.
Consider funding your short-term investment bucket by using more conservative short- to medium-term bonds in your medium-term investment bucket, as they are often the most stable assets. To replenish your mid-term bucket, you can take earnings from assets that grow in the long-term bucket and reallocate them. Ideally, you’ll follow an appropriate asset allocation strategy based on your goals, time horizon, and cash needs, so this should flow into your investment process.
Strategy #2: Fundamentals vs Discretion
How this works: With this approach, the goal is to use retirement savings to cover basic expenses (such as housing, health care, and daily living expenses) and invest it in assets that generate guaranteed income, such as annuities. The remaining savings will be used only for discretionary expenses (like travel, non-essential home improvements, etc.) and will continue to be invested in more growth-oriented vehicles like stocks.
shortcoming: The downside of this approach is that some discretionary expenses may actually be considered essential for individuals considering a minimal retirement lifestyle. If, for some reason, their discretionary assets don’t last, these individuals may prefer to keep working until that lifestyle is realized, rather than living more frugally in retirement.
what can make it work better: Consider dividing your savings into 3 buckets, but labelled differently: essentials, discretionary non-negotiable items (travel to visit friends and family), and truly discretionary (such as taking your whole family around the world when the time comes) travel instead of entertaining grandkids at home when the market is down). Individuals looking for a minimal retirement lifestyle can put necessary and non-negotiable expenses into a guaranteed income bucket. The remaining assets are then set aside as truly discretionary items where they can live or wait without necessity.
Strategy #3: Fixed Rate Withdrawals
How this works: This strategy is also known as (jargon warning) systematic withdrawals. This is the process of withdrawing funds from your retirement account based on a regularly scheduled fixed (percentage or dollar) amount. For example, a popular method of system withdrawals is the 4% rule. The idea behind this rule is that you can “safely withdraw” 4% of your initial savings and increase that amount each year with inflation, with a high chance of running out of funds.
shortcoming: Disadvantages include the risk of a significant market downturn in early retirement, or failure to take into account an individual’s various income needs, lifestyle and family dynamics. For example, if you need $5,000 per month and your regular income (Social Security, pension, annuity) brings you to $4,000 per month, then you need an extra $1,000 anyway (whether it’s $4.50 or your savings 10%) occurred. In other words, one size doesn’t fit all, which means there’s no guarantee that the 4% rule itself is the best method for you.
what can make it work better: This approach can play a role in the above considerations as long as you also have some rules in place about how to change retirement withdrawals based on what the market/your investment savings do. For example, you might reduce your withdrawal percentage during a market downturn, and/or might leverage stable and liquid assets (such as a cash savings account) to help meet your needs while letting those investments take some time to recover. For example, I A colleague said he plans to keep his 3-year payouts in cash, and when the market is down, he may reduce withdrawals to 3% and replenish his needs from cash reserves until his other assets recover .
How to decide which is right for you?
Since there really is no one-size-fits-all approach, establishing these rules requires thought, vision, and planning. All of these strategies require you to understand your annual financial needs.Consider consulting Qualified and impartial financial planner Help you determine how much income you need and the best retirement withdrawal method for you. They can also help you maintain and update your strategy as you go along. Don’t be too afraid of recessions and bear markets, because with proper planning and preparation, you can develop a withdrawal strategy that will last through the worst of circumstances, while helping to ensure that your savings will last for the rest of your life!