For each year in which a bull market persists, workers become likelier to retire. However, those who leave the workforce now—the ninth year of the longest U.S. bull market—are potentially setting themselves up for a tough stretch that could test their portfolio’s long-term resilience.
Live long enough and you’ll get to experience the ups and downs of the market. If you’re about to retire, or newly-retired, you may be concerned about how long this bull market can maintain its pace. There is a way to deal with this, says The Wall Street Journal in its article “Retiring Soon? Plan for Market Downturns,” with steps that you can take to minimize the damage from losses in early retirement.
A little history first. When the stock market is historically expensive, as some say it is right now, it’s often a sign that future returns won’t be able to keep up. If you live for two or three decades after retirement, a combination of withdrawals and poor returns will mean there’s less in your accounts to compound.
Let’s say you’re a 65-year-old retiree with $1 million in your retirement funds. If you withdraw 4%, or $40,000 in the first year of retirement, and then your portfolio sinks by 40% shortly after that, you’ll have just $576,000 left to fund a retirement that could last decades. It won’t be easy to recover from that early first hit.
Returns in the first five to 10 years of a retirement matter the most. However, that doesn’t mean you should cancel your retirement. For one thing, you can never time a market. If that was possible, we’d all be zillionaires. If you are ready to leave your job, extending your work life could make you mentally and physically ill. There are steps you can take. However, remember that there are also trade-offs.
Build a cash cushion. A one to five-year cushion of living expenses in cash gives you more flexibility when markets tank. You don’t want to have to sell into a down-market. Retirees with cash buffers tend to panic far less than those who are completely vested in equities.
The trade-off? Low returns on cash will reduce your long-term returns. Some advisors suggest using bonds as a buffer, but if you need to liquidate the bonds to compensate for living expenses, the buffer will also shrink.
Rebalance. Some experts say that a better strategy is to invest in a truly diversified portfolio and rebalance after all market swings. You can then use your winnings to cover a portion of living expenses. This approach gives you the opportunity to sell holdings that have appreciated the most, while buying things that have declined and are relatively cheap. When the turnaround arrives, your portfolio will recover faster.
Try another kind of buffer. Some advisors recommend using home-equity lines of credit or reverse mortgages to create a cash buffer that doesn’t tie up your portfolio. However, both have costs. Reverse mortgages are still expensive and with a home equity line of credit, you must make monthly payments. Both charge interest. You could also tap the cash value of your permanent life insurance.
The idea is to build yourself a comfortable financial zone that protects your portfolio, thereby reducing your risk and panic attacks at the same time.
Reference: The Wall Street Journal (Sep. 21, 2018) “Retiring Soon? Plan for Market Downturns”