The stock market can be a scary place for those of us that are retired or getting close to that time in our lives. We spend a lifetime saving and investing, paying off debt, planning, and dreaming. We build a nest egg that we want to last us the rest of our lives. Naturally, retirement-era investing in volatile products can be scary. Those of us that experienced the market meltdown of 2008 can remember the pain that caused millions of Americans, as the S&P 500* lost 48% of its value (Atlanta, 2009)in a matter of months.
With all that volatility and danger of loss, why do most sound financial plans involve at least SOME money invested in the market? The answer is relatively simple. Historically, a mix of market-based and fixed-income investments has shown to give you the best chance of having your money last as long as you do.
The problem is…when you retire, you’re a seller and not a buyer anymore. As you sell investments to provide yourself with retirement income, you sure don’t want to sell the ones that have lost a lot of value. Selling investments that have lost half their value is a difficult proposition.
What’s a good strategy to deal with that problem? How can we build a financial plan that helps us avoid selling investments at a loss, but still provides retirees with the income they need? The answer is relatively simple. Set up your retirement dollars in 3 divisions similar to this:
Section 1:
Immediate needs. This is most likely in a money market account or some other liquid investment. This is money you’re going to need to use in the next year or two. The interest it earns isn’t as important as the accessibility of it.
If you needed $40,000 per year to fund your retirement income, you could set $80,000 aside in a money market account and draw it down until it’s gone. As it approaches zero, you can then fund it back up from your other sources.
Section 2:
This would traditionally be a portfolio of safer, fixed-interest tools that seek to offer steady returns and not a lot of volatility. This section can likely support 5-8 more years of income needs as a total.
Our $40,000 annual need would then equal somewhere around $300,000 in this section of our plan.
Section 3:
This is longer term and can consist of equities or more volatile investments. The time horizon for this one is usually around ten years or more. It can have very dramatic gains and losses from year to year, however it may offer greater returns over a long period of time. The idea is that if or when this part of your portfolio has a downturn, you can wait for it turn around. The safety and security of sections 1 and 2 should support your needs for several years and may keep you from having to “raid” section 3 at a bad time.
Here is the smart strategy that may allow you to prosper. As you deplete your immediate money (the $80,000 you have in the money market), you can choose which section to replenish it with. If your long-term section (#3) has performed well, you can choose to use some of it to raise cash. In essence, sell your winners. If not, then you can use funds from bucket 2 while you wait for the more volatile portion of your portfolio to recover from any downturn.
All in all, this approach to retirement funding does take a bit of planning. You periodically will need to work with your advisor to make sure the three “buckets” of money are all doing what they should be. It is, however, an excellent way to use more volatile investments while potentially reducing your risk of selling at a loss. It also gives you the chance to take advantage of the potentially higher returns that those volatile investments can provide over time.
Remember, you’re not going to be retired for one year. Hopefully you have many years to enjoy a retired lifestyle. Aim to maximize your investment performance as well as you can so that you might have income to live life the way you always wanted!
*The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The S&P 500 is an unmanaged index which cannot be invested into directly. Past performance is no guarantee of future results.
No strategy assures success or protects against loss.