The stock market has taken investors on a pretty wild ride over the past several months. It is during these volatile times that we experience a higher number of calls from people who are concerned about their retirement savings and wondering what they should do. My most concerned callers are those who are getting close to retirement. With the bells from the 2008 financial crisis ringing clearly in their heads, they are asking, “What should I do if I retire into a bear market?”
Here are three different strategies to consider that can allow you to still retire when you want to without the market fluctuations (or downturn) affecting your plans or causing you to run out of money sooner than you originally projected.
Strategy #1: The bucket strategy
To use some jargon, this is also called the time-based segmentation approach. With this strategy, you think of your money in 3 hypothetical buckets that are aligned with your spending needs and the time line for those needs. For example:
Bucket 1 (Short-term): This is the money that you anticipate needing to withdraw over the next 3 to 5 years. Most people will put this bucket in cash or in very conservative investments. The idea is that this money is protected from market down turns, while the rest of your investments can have time to recover (aka grow back with the market) before you need to begin withdrawing them.
Bucket 2 (Medium-term): This bucket is the money that you may need within a 5 to 10-year period. Most people would invest this bucket in medium and longer-term fixed income assets such as bonds or bond funds.
Bucket 3 (Long-term): This is basically the rest of your money, which you estimate you won’t need to withdraw for 10 or more years, and therefore what you want to keep growing. You’ll typically use stocks (aka equities) for this bucket, as you’ll have time for this money to recover from any longer-term bear markets and ideally will continue its growth over the years.
My colleague Chris Setter wrote in greater detail about the Bucket Strategy here.
The drawbacks: It can often be difficult to trust the process and not let emotions get in the way. During up markets, you may feel like the cash you set aside is just not working hard enough and that you should take on more risk.
Likewise, during down markets you might start feeling anxious and like you should move your money into cash for safety. Both reactions can hurt you, as it is nearly impossible to time markets and more often than not you will only contribute to a reduction in how long your money will last.
In addition, it can be challenging to manage money you have across different accounts like tax-free, taxable, and tax -deferred accounts as you may want to keep different types of investments in different types of accounts (for example, higher growth in a tax-free account like a Roth so that you can earn tax-free growth, while municipal bonds earning tax-free interest make more sense in a taxable account.)
What can make it work better: Sticking to your plan and having a strategy in place to replenish and reallocate your buckets while being mindful of the type of accounts your assets are invested is the key to success with this strategy.
Consider funding your short-term bucket by using the more conservative short to medium term bonds in your medium-term bucket, as they are typically the assets that will be most stable. To replenish your medium-term bucket, you can take the gains from the assets that have grown in your long-term bucket and reallocate them.
Strategy #2: Essential vs discretionary
With this approach, the goal is to take retirement savings that you need to fund essential expenses (such as housing, healthcare and daily living expenses) and invest them into assets that produce guaranteed income such as annuities. The remaining savings would only be used for discretionary expenses (like travel, non-essential home improvements, etc.) and would remain invested in more growth-oriented vehicles such as stocks.
The drawbacks: The drawback to this method is that some discretionary expenses might actually be considered essential to an individual with a certain retirement lifestyle in mind. If for some reason their discretionary assets did not last, then those individuals might have preferred to continue working until that lifestyle could have been accomplished versus living more frugally in retirement.
What can make it work better: If that’s the case, then maybe think of your savings again in 3 buckets, but with different labels: the Essentials, the Discretionary Non-Negotiables (such as a country club membership), and the truly Discretionary (like taking your whole family on a Disney cruise when times are good, versus just hosting the grandkids at your home when the market is down).
Individuals looking to secure a minimum retirement lifestyle could then place the expenses that are essential and non-negotiable into guaranteed income buckets, and the remaining assets to the truly discretionary items that they would not really miss if push came to shove.
Strategy #3: Structured systematic withdrawals
A systematic withdrawal refers to the process of taking money out of your retirement accounts based on regularly scheduled fixed (percentage or dollar) amounts. For example, a popular systematic withdrawal rule is the 4% rule. The idea behind this rule is that you can “safely withdraw” 4% a year from your savings for the duration of your retirement and as long as you stick to that amount or less, you shouldn’t (in theory) run out of money.
The drawbacks: As my colleague Scott points out in his article, the drawbacks include not taking into account the timing at which you retire (for example, a 40% down market) or the various income needs, lifestyle, and family dynamics of individuals. In other words, one size doesn’t fit all, which means there is no guarantee that the 4% rule in and of itself is the best approach for you.
What can make it work better: This approach can work in the above considerations as long as you also build in decision rules around certain triggers that would lead you to take action during certain market events. For example, perhaps you would reduce your withdrawal percentage during down markets, and/or possibly tap into stable and liquid assets (such as a cash savings account) to help meet your needs while allowing the investment assets that have taken a beating some time to recover.
For example, a colleague of mine shares that he plans to keep 3 years of expenses in cash, and when market downturns occur he might reduce his withdrawal to 3% and supplement his needs from his cash reserves.
How to decide which is right for you?
Since there really isn’t a one size fits all approach, setting up these rules will require thought, foresight and planning.
All of these strategies require you to have an idea of what your annual financial needs will be – use these 5 steps to help determine the retirement income you are aiming for, and then consider consulting with a qualified and unbiased financial planner to help you determine what the best retirement withdrawal approach is for you. They can also help you maintain and update your strategy as you go along.
With proper planning and preparation, anyone can develop a strategy that can outlast the scariest of bear markets, while helping to ensure that your savings can last to infinity and beyond!