Protect Your Nest Egg From a Volatile Market

The dream of a secure and relaxing retirement seems to grow more and more elusive with each passing year.

Part of the reason: The onus is on the individual more than ever to build a healthy retirement nest egg, often depending on the stock market to help fuel that growth.

And, as everyone knows, the stock market can be fickle. Today's gains can be wiped out by tomorrow's losses.

Many people will recall that retirement once involved what could be thought of as a three-legged financial stool. Social Security and personal savings were two of those legs, and they remain, even if they appear wobbly at times. But for most people, the stool's third leg—a pension—has disappeared.

That puts even more pressure on making sure your savings is strong and, as you near retirement, protected from a volatile market that, on one bad day, could wash away decades of sacrifice on your part.

In short, the thing that can affect you most in retirement is an unlucky sequence of returns.

What does that mean? Simply this: When you're saving for retirement, the order of your gains and losses usually doesn't have a major impact because, over time, they tend to average out.

That changes once you begin making withdrawals from your retirement savings. Big losses in the first years of retirement can be especially devastating because your portfolio's value now is being hit by a double whammy—the market drop and you taking out money to live on.

That means, when the market turns around and you start experiencing plus years, you have a much more difficult time recovering because your balance dropped so low. And on top of that, you're still withdrawing money, making any overall market gain less valuable for you as an individual.

A huge loss early in retirement also means that the withdrawal amount you need to maintain your lifestyle begins to represent a higher percentage of your overall portfolio.

To show you what I mean, think of the rule-of-thumb that you should plan to withdraw 4% of your savings each year in retirement.

Here's how a volatile market can wreak havoc with that 4% rule. Hypothetically, let's say you retired at 66 with $1 million in savings and decided that withdrawing $40,000 (4%) each year would provide you what you needed to live on when coupled with Social Security.

So far, so good.

But it wasn't so good in 2008 when the market tumbled drastically, cutting some portfolios in half. Suddenly, the value of that $1 million retirement savings might have been $500,000 if it was all allocated in investments subject to stock market volatility, and a $40,000 withdrawal would be 8%, not 4%, or your portfolio.

It would take some extraordinarily great years in the market to recover from that, especially with you continuing to lower the principal each year with your withdrawals.

That's why as you near retirement you want to re-examine your investments to see how you can lower your portfolio's exposure to market volatility.

Portfolio planning involves more than investing in stocks, crossing your fingers and hoping it all works out. You want to make sure you are diversified beyond stocks and bonds. Other places you could allocate your assets could include real estate, commodities and annuities, but you'll want to speak with your financial adviser to determine what might work best for your individual situation.

Sure, the low-volatility approach means you'll miss out on any amazing years with 30% gains in the market.

Don't beat yourself up too much, though.

You'll also dodge those years when the market crashes, leaving you with no good way to recover.

Kim MacCormack contributed to this article.

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