Tips for Protecting Your Retirement Savings
Recent market volatility has some retirees worried about the safety of their retirement savings, likely with good reason. While investors who are decades away from retirement have plenty of time to recover from a market correction, those nearing or currently living in retirement do not have the luxury of time on their side. But don’t despair! The following tips can help mitigate the risk of a market pullback in early retirement.
Tip #1 – Maintain short-term and long-term investments
Let’s clarify an important point. Many retirees believe that because they’ve reached retirement, they are short-term investors. That’s true to an extent, as they are relying on investments (in part) to fund their daily living expenses. However, just because you’ve retired doesn’t mean you shouldn’t invest for the long term.
It’s not uncommon for retirees to live for 20 to 30 years in retirement. If you retire at age 65 and move all your investments into short-term vehicles, you’re going to miss out on a lot of growth opportunities while losing purchasing power to inflation over the next couple of decades. Therefore, you need to build a portfolio that supports your current lifestyle without losing focus on your longer-term goals — those that are several decades in the future.
To accomplish this, consider taking a two-pronged approach:
- Maintain three to five years of living expenses in shorter-term, liquid investments. Consider a mix of fixed income securities like individual bonds or bond funds to provide capital for your monthly income Additionally, when the stock market is volatile, this allocation to bonds provides access to funds that can be used to rebalance your portfolio, adding to stocks at a discounted price. Lastly, having a short-term allocation to bonds provides cushion within the portfolio for ongoing or one-time distributions. If the equity market is trending downward, creating cash from the bond side of your portfolio will prevent you from having to sell out of stocks when markets are low.
- Maintain the majority of your retirement savings in a diversified portfolio (see below) with a focus on growth and inflation protection. While this allocation should be in line with your overall risk tolerance and investment objectives, it can be invested in riskier assets than your short-term investments. Remember, if you need your portfolio to last for several decades, a significant portion should be allocated toward capital appreciation and your longer-term goals. Your wealth manager can help you identify opportune times to transfer assets from your long-term allocation to your short-term allocation, as we are always looking to facilitate this transfer in a tax-efficient and sustainable manner.
Tip #2 – Focus on diversification.
Regardless of the current market environment, it’s always wise for retirees to maintain a diversified portfolio. Investing in different types of assets allows investors to take advantage of the cyclical nature of markets while minimizing overall risk in the portfolio. Therefore, when one sector or investment type is performing poorly, another investment type that’s performing better can help smooth out volatility. Diversification won’t prevent losses, but it can reduce the risk of being too heavily invested in the worst-performing part of the market at the wrong time. You can diversify by combining stocks with bonds, large company stocks with small company stocks, U.S. stocks with international stocks, and through stocks from different sectors, like technology, financial, energy, healthcare, etc.
Tip #3 – Follow a disciplined spend-down strategy.
You can also mitigate the risk of market volatility on your overall investment portfolio by establishing and following a disciplined withdrawal strategy. Plan on consistently monitoring and tracking your current financial situation and goals. Keep an open line of communication with your wealth manager and work with him or her to develop a strategy on how to coordinate withdrawals and retirement income to support your lifestyle. It’s important to understand the tax implications of your various income sources and withdrawal strategies; your wealth manager can assist in creating a tax-efficient strategy to help you achieve your goals.
Based on your specific goals, tax situation and income needs, here are two commonly used withdrawal strategies to consider:
- Traditional approach – Using this approach, you would withdraw from one account at a time. Typically, the order of withdrawals is from taxable accounts first, followed by tax-deferred accounts and, finally, tax-exempt accounts. This approach allows tax-advantaged accounts to continue growing tax deferred/free for a longer period of time. The challenge, however, is that you’ll likely have more taxable income in some years than others. It’s important to maintain flexibility and be mindful of your current (and future) tax situation when executing a distribution plan.
- Proportional approach – This withdrawal strategy establishes a target percentage that will be withdrawn from each account each year. This amount is typically based on the proportion of retirement savings in each account type. Over time, this strategy should lead to a more stable tax bill from year to year and spreads out your tax liability over the course of your retirement.
With any withdrawal strategy, the key is having a baseline spending goal that should be tracked and revisited on an annual basis. Unexpected costs will always occur; the key to success is having the self-discipline to spot and address when spending levels are too high for any extended period. Don’t let a temporary increase in spending adversely affect your retirement goals — do what’s required to get back on track and stay committed to the bigger picture. The benefit of having a disciplined approach is that it helps to ensure enough assets are available to last throughout your lifetime, regardless of market volatility.
Interested in learning more about how market risk may impact your retirement savings? Contact us to schedule a call with a member of our team. We look forward to getting to know you.