Running out of money in retirement is a serious concern for many people. Most people envision retirement as a joyful time filled with leisure activities, traveling and other aspirations. However, when people quit working and earning an income, an uncomfortable reality sets in: They realize their savings need to last for the rest of their lives.
One of the biggest threats to your portfolio in retirement is called sequence of return risk. It’s the risk of depleting your portfolio due to withdrawing money during periods when the markets are falling. When you take money out of your portfolio during these times, your account losses snowball.
Whether you get a good sequence or bad when you begin your retirement is a matter of luck. You can’t control the direction of the market, but you can control how you react when your portfolio experiences a bad sequence.
Here are some strategies that may be effective in reducing the risk if you do run into a poor sequence.
Written by Matthew Stratman, a financial adviser at Western International Securities (opens in new tab) in Southern California. His focus is helping business owners and entrepreneurs who are planning for retirement. Matt is extremely passionate about retirement planning, believing the better prepared a person is, the more fulfilling their retirement will be.
1. Diversify to reduce the volatility within your portfolio.
When a portfolio is highly concentrated in a single asset class it may be more vulnerable to economic shifts and increased volatility. A diversified portfolio will have a mixture of stocks, bonds and other investments like annuities and real estate. Within the asset classes of stocks there are funds that invest in large, midsize and small companies, international and emerging markets. There are also sector specific categories like health care, technology, consumer staples, etc. A diversified portfolio will get the average return of all the investments within it. When we enter a bear market, your diversified portfolio will likely have some investments that are still performing positively with a reduced exposure to assets that aren’t.
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2. Consider investing a portion of your money into an annuity.
These investments are contracts, guaranteed by insurance companies, that provide income for a specified period. Many annuities will guarantee an income stream for your entire lifetime. This portion of your portfolio could be used for mandatory expenses like bills, food, etc. With the rest of your portfolio you can be more aggressive and strive for higher growth and income.
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3. Adopt an adaptive withdrawal (and spending) plan.
Be flexible with your discretionary retirement spending, and be willing to reduce income when needed. By setting guardrails you know when to decrease the income in the years when the portfolio is in decline. Having an adaptive withdrawal strategy will allow for higher income in years when the portfolio is rising and help protect your principal during a decline.
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4. Treat your home as an asset, and use it wisely.
For those who own their home and have equity, you can consider creating a safety net for yourself by opening a home equity line of credit. By having this option available, you will have access to funds but will only owe interest on the money you withdraw. This can be implemented in tandem with your adaptive withdrawal strategy by accessing the line of credit when the portfolio is in decline. When the market begins to rise again you can pay back the amount borrowed.
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5. Make sure you have enough cash in the bank to cover your expenses over the next six to 12 months.
While times are good it is possible to draw income from the investment account. When the investment account is declining it may be a better idea to let the dividends and interest reinvest. During those negative periods you can draw upon your bank account. Even though current interest rates are low, money in the bank will ensure that you won’t need to withdraw from your investments during a short-term market loss.
Whether or not you choose to implement these methods it is wise to approach retirement with a thoughtful plan. Knowing how you are going to respond when the market moves in different directions will help you avoid knee-jerk reactions that may be detrimental to your longer-term strategy. Ultimately a solid plan will give you the peace of mind necessary to live the retirement you’ve envisioned rather than fretting over forces that you can’t control.
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