Are high inflation and the bear market derailing your retirement plans?
There are significantly more challenges for retirees or those close to retirement. Paying more for gas, groceries, and other items on a fixed income while watching your investment portfolio build over a lifetime decline in value is challenging. We spoke to several financial experts on retirement planning, considering several options to help retirees better weather market downturns.
Bear markets are scary for investors, but they can be particularly treacherous for retirees or those about to retire. The timing of bear markets which are market downturns of 20% from their recent peak, and how long they’ll last is usually unpredictable. On average, bear markets come every 3.5 years and last 9.5 months.
Suppose you have years before you retire. In that case, you have more years to save money, and less pressure to do so and this piece may help you recognize the necessity of starting early in life and consistently putting retirement savings away.
Start Retirement Planning Early
It’s a good idea to work with a financial advisor (i.e., CFP) for retirement planning well ahead and to review your financial plan with them periodically. Your financial plan will likely account for market downturns.
But even the best plans may reflect gaps from unexpected events in your family or economic forces. The highest inflation rates in 40 years are surprising to economists, and the Ukraine war with Russia exacerbates existing supply issues. These factors require the Fed to raise interest rates more aggressively, pushing us into a recession many believe we are already experiencing.
If you are approaching your retirement, consider evaluating working a couple of years longer, delaying taking social security, or modifying your investment portfolio. With these economic issues, you’ll have more challenges. Consider speaking with your financial advisor to review your financial plan and investment portfolio.
The panic and fear of outliving your money during your retirement years are real for many. Once a bear market arrives, it is natural to get emotional and potentially make investment mistakes.
A Vanguard June 2020 study estimates that if you are retiring in a bear market with a balanced portfolio (50/50 for stocks and bonds) and rely on that portfolio for 100% of your income, making withdrawals when stocks are down could increase the chance you outlive your money by 31% and reduce your income stream by 11%.
We spoke to several financial experts, considering several options to help retirees better weather market downturns.
Retirement Planning Tips In A Bear Market
Avoid Panic Selling And Try To Ride Out The Storm
Emotional reactions may drive you to sell investments. It may lead to inefficient decisions. Michael R. Acosta, CFP®, ChFC® of Consolidated Planning, warns, “Investors should spend less time listening and watching the news. They should also focus on what they can control, which comes down to how much they’re saving and how much they’re spending.”
Alexis Woodward, CFP®, CDAA™ and Co-Founder of Blend Wealth, says, “Sticking to your investment is also a simple solution during a bear market. The fundamentals of investing stays the same even during a bear market. If you have a financial plan in place, it’s already accounted for volatility and market downturns.”
Delay Your Retirement
If you’re about to retire, you should continue working a couple of years longer. Many people want to transition into retirement by working part-time. Not everyone can extend their work years as many work in some private and public sector jobs with mandatory retirement age rules still in force starting in their mid-50s.
Make sure you understand how Social Security system works and the retirement benefits coming in 2023, with higher contribution limits for your retirement plans.
Consult With Your Financial Advisor
Contact your financial advisor to review your financial goals and how your plan reflects potential market downturns. Yale Bock, CFA, President, YH & C Investments, referring to the bear market, says, “If you are investing over the long term, it might be a good idea to go through what you own with your advisor position by position. The holdings you are not comfortable with should be looked at extensively. Positions you own that you have faith in are candidates for additional purchases, especially if the price has dipped dramatically. You also might look at ways to benefit from inflation, be it energy or inflation-adjusted holdings (TIPS).”
Bolster Your Cash Reserves
When nearing retirement, you should boost your cash reserves to weather market volatility. That often means selling stocks at the bottom. You’ll want to evaluate ways to find extra cash, so you don’t have to liquidate your investments to pay for living expenses.
Eric Maldonaldo, CFP, founder of Aquila Wealth Advisors, LLC, recommends that people “create a separate “Recession Proof Fund” savings account. This account has two years’ worth of living expenses in cash at retirement. If there is a bear market, it allows you to stop drawing on your investment until the market recovers.”
Re-Evaluate Your Budget
You want to right-size your budget for retirement by tracking and reducing spending, eliminating debt, and avoiding carrying any credit card balances—delay making more significant purchases during high inflation and market downturns until there is more economic stability.
Having access to liquidity during retirement becomes essential for avoiding the need to sell securities in a down market to pay for your living costs.
Asset Allocation And Rebalancing
Asset allocation is a form of diversification in which the investor decides on the proportions of an investment portfolio that will be devoted to various asset classes, including stocks, bonds, cash equivalents (i.e., money markets), real estate, gold, and other commodities.
As markets go up or down in one asset class, proportions may shift away from your risk tolerance in retirement. A bear market or a significant move in the market may require portfolio rebalancing to keep your risk level in check and minimize your risk.
Woodward recommends, “Rebalancing your portfolio is another strategy to consider during downturns if you want to retire early because it helps control risk and prepare your portfolio for the rebound to maximize your return.”
Kevin Lao, CFP, Founder, Imagine Financial Security says, “The trick is to coordinate your rebalancing because if you just spend the now bucket (i.e., bucket strategy discussed below) at the beginning of your retirement, you end up getting more and more aggressive as you go through retirement savings.”
Take Advantage of Tax Loss Harvesting
It’s painful to realize investment losses in a down market. However, those losses can help you reduce your taxes by offsetting your gains now or in future years. Bear markets are an excellent time to take advantage of tax loss harvesting. Woodward says, “Tax loss harvesting takes lemons and makes lemonade by harvesting or selling at a loss. You can use those losses to lower or eliminate future taxes on capital gains.”
Another benefit of down markets is Roth conversions. Roth IRAs have preferable benefits as you contribute after-tax dollars, your money grows tax-free, and you can make withdrawals after the age 59.5 years, tax-free and penalty-free compared to Traditional IRAs. Traditional IRAs began in the mid-1970s. Roth IRAs were available in 1997, while Roth 401Ks were available as of 2006.
Only 29% or over 60 million taxpayers own IRAs, including traditional IRAs, Roth IRAs, Simplified Employee Pensions (SEP IRAs), and Savings Incentive Match Plans for Employees (SIMPLE IRAs). Taxpayers can own multiple types of IRAs, with 23% owning traditional IRAs, while about 10% own Roth IRAs.
Marcus Blanchard, CFP, Focal Point Financial Planning Founder, says, “Consider Roth Conversions. Falling markets present a great opportunity to proactively shift funds from your tax-deferred accounts (IRA/401K) to a Roth IRA/Roth 401K. Since we expect markets to recover and continue growing over time, converting funds to a Roth account while the market locks in tax savings and future tax-free growth for you. For example, say you have 100 shares of an investment worth $10,000 at the beginning of the year, and now they are worth $7,000 after the market dropped. Once the market recovers, you will have avoided paying tax on the $3,000 of growth back to even, not even considering the future growth above that. Bear markets are Roth conversion opportunities on sale. “
Take or Delay Social Security
Retirees may claim social security income sooner, ahead of the full retirement age at 70 years, if they need the inflation-protected income. However, leave some money on the table by not waiting for more. If you start receiving benefits at age 66, you get 100 percent of your monthly use. However, suppose you delay receiving retirement benefits until after your full retirement age, or 48 months more. In that case, your monthly income continues to increase up to 132% of the monthly benefit to collect social security.
Retirement Bucket Strategy
The retirement bucket strategy is a withdrawal strategy that enables investors to pull money from available income sources. There are three buckets representing varying purposes and timeframes. The first bucket is short-term, with safer and liquid investments. The second is an intermediate-term containing moderate-risk investments, including bonds, and the third holds long-term securities, including stocks.
Lao recommends the three-bucket strategy for future retirees: “One way to hedge bear market risk as you approach or enter retirement.” He explains, “This strategy involves creating ‘Now,’ ‘Soon,’ and ‘Later’ buckets. The Now bucket could incorporate a CD ladder or individual bond ladder, short-duration bonds, treasuries, or other fixed income alternatives. The later (or third) bucket might include some conservative investments but would have a healthy percentage allocated towards more aggressive investments to combat inflation.” The “Soon” bucket is the second or intermediate bucket that contains moderate-risk investments, usually bonds.
Marcus Blanchard adds, “Make sure your ‘safety bucket’ is full. What I mean by that is to make sure you have at least five years of your expenses to help in safer investments like cash & bonds. How that mix looks between cash and investment-grade bonds (short-term vs. long-term) is up to you. These safer investments may feel like holding you back in a rising market, but just like a seatbelt, they will help catch when the market gets in a wreck.”
You want to avoid early withdrawals from your nest egg during market downturns. Financial advisor William Bengen originated the 4% rule in 1994. He based his thesis on the 4% “safe withdrawal” rate as a rule of thumb for retirees to be able to take out annual income from a 50/50 balanced investment portfolio of stocks and bonds and more likely not outlive their money. For example, a retiree could take out $40,000 in annual income of a $1 million portfolio (i.e., $1 million x 0.04) in the first year of a 30-year retirement, making adjustments for inflation in future years.
With greater life longevity, lower bond yields, and risk tolerance, retirees may find more comfort in a more conservative 3% withdrawal rate to allow their portfolios to last longer.
Late in December, President Biden signed the Secure 2.0 Act into law, providing many positive changes to retirement benefits that become effective in 2023 and beyond.
For those retiring early at age 50, taking social security is not yet an option. Lao suggests a bridge option to create an income floor strategy. He says, “You might consider a fixed period annuity to bridge the gap until you start Social Security at age 70. For example, if you retire at 50 and plan to take social security at 70, you could buy a 20-year immediate annuity. When you take social security, it will replace the income floor.” That would mean using some of your retirement assets to buy an annuity, allowing you to wait to age 70 to get a social security income.
Side Gigs For Retirees
There are many reasons why retirees may want to continue to work part-time or full-time, and they have a wide range of job opportunities.
According to a Transamerica Center For Retirement Studies survey, many workers expect to retire after age 65 or never retire. The majority (55%) of workers plan to work in retirement either part-time (41%) or full-time (14%). Those not planning to retire after age 65 cite financial reasons and staying active as top grounds to wait to retire.
Retiring or about to be in a bear market while inflation is raging is quite challenging. It is easy to panic and make money mistakes during this time. Instead, be proactive and meet with your advisor to review your plan and investment portfolio to consider whether you need to make any changes.
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With a passion for investing and personal finance, I began The Cents of Money to help and teach others. My experience as an equity analyst, professor, and mom provide me with unique insights about money and wealth creation and a desire to share with you.