Protect Retirement Portfolio in a Market Downturn

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Many investors got a sharp jolt in December when the S&P 500 plunged nearly 20 percent from its September high. That drop helped pull down year-end 401(k) balances by more than 8 percent on average compared with the previous year, according to Fidelity, though the markets partly rebounded in January.

If you’re still working and saving for retirement, you can take these market drops in stride, since your investments have time to recover. But if you're within a few years of retirement, or recently retired, this volatility is a reminder to review your portfolio. Big losses, especially in the early years of retirement, could derail your finances if you haven't planned for them.

To understand the danger of market losses when you're launching into retirement, consider this example from Baird, a wealth management firm in Milwaukee:

Say there are two 65-year-old retirees, each with $1 million. Both use a 5 percent initial withdrawal rate and earn an average annual 6 percent return. But the order of the returns they receive is different.

One retiree is hit by double-digit losses in each of the first three years of retirement. The other experiences those same losses later, at ages 88, 89 and 90.

If the first investor doesn't change his withdrawal rate, the portfolio will run out of money by age 83, because the account is too depleted to deliver enough growth. The second retiree has more than $2.5 million by age 90.

This is not to suggest that a major downturn is about to arrive—no one can accurately forecast market trends. But if you're a retiree or pre-retiree, you will want to be sure your financial plan can hold up if markets plunge.

"The good news is that retirees can prepare and adapt, which can help you survive a downturn," says Jonathan Guyton, a certified financial planner with Cornerstone Wealth Advisors in Edina, Minn. These six moves can help you prepare.

Fund a Cash Account

As you approach retirement, start building up enough cash to help you meet your essential expenses even if markets enter a prolonged slump. With these savings on hand, you can avoid tapping your retirement portfolio at market lows.

For most retirees, keeping the equivalent of two years of expenses is a reasonable target, says Judith Ward senior financial planner at T. Rowe Price. Typically a balanced portfolio (60 percent stocks and 40 percent bonds) bounces back after a bear market within two years, according to T. Rowe Price research.

Your cash should be kept safe and accessible in a bank or credit union savings account. You can generally earn the highest interest rates at online banks—some institutions are paying more than 2 percent, according to Bankrate.com. (For more on your savings options, check out these places to put your cash now.)

Analyze Your Budget

Be sure to do a detailed review of your retirement expenses, so you know exactly how much you will need to spend on essentials, such as housing and utilities. You can also identify discretionary items that can be trimmed or eliminated if necessary—dining out less often, for example, or skipping a cruise.

It may be harder than you think to cut back on discretionary spending when you retire. Many people tend to splurge, especially on travel and housing renovation, hitting peak spending at the time of retirement then tapering down over the next three years, according to research by J.P. Morgan Asset Management.

All the more reason to scrutinize your spending now, so you can find a way to fund a few splurges, even in a tough market. This AARP budgeting calculator can help you get started.

Revisit Your Asset Mix

It’s important to keep a stake in stocks, even in retirement, in order to get enough growth to sustain your income. Most retirees can do well by starting out with 40 percent to 60 percent in stocks, with the rest in bonds, says Guyton.

Still, if you think a bear market will cause you sleepless nights, consider cutting back a bit on equities. “If you decide it’s wise to have a lower stock allocation, now might be a good time to take advantage of the recent market rally to make your shift,” says Wade Pfau, professor of retirement income at the American College for Financial Services.

Don’t overlook your fixed-income funds. While Treasury bonds tend to hold up in stock market downturns, emerging market bonds, junk bonds, and even high-quality corporate bonds can take a hit. In 2008 the Vanguard Intermediate-Term Corporate Bond fund (VFICX) lost more than 6 percent while the Vanguard Intermediate-Term Treasury fund (VFITX) gained 13 percent.

The typical core bond index fund—one that tracks the Bloomberg Barclays U.S. Aggregate index—currently holds a 30 percent stake in corporate bonds. Risk-averse investors should consider shifting at least some money to a low-cost Treasury bond fund, says Guyton.

Keep Working If You Can

If you aren’t sure you’ll be financially prepared for retirement, consider staying at your job a bit longer. Those extra years of income can help you build a cash cushion, as well as postpone Social Security claiming, which can boost your benefit; more on that below.

Granted, working longer can be a challenge. But it will help to keep up your skills by taking advantage of any employer training that is offered, or by developing new skills outside the workplace, says Kerry Hannon, author of “Great Jobs for Everyone 50+.”

If you can’t remain at your current employer full time, plan a transition to a second career after retirement, a process that could take three to five years. “You need time to do your soul searching and research, and you may need to pick up some training certification,” says Hannon.

To learn about second career possibilities, you can attend industry seminars, as well as take classes at a community college or online. LinkedIn Learning (formerly Lynda.com) offers unlimited classes starting at $24.99 a month, and EdX, Coursera and Udemy offer thousands of classes. For more career tips for older workers, go to the AARP.org/work.

Choose a Cautious Withdrawal Rate

The standard rule of thumb for retirement withdrawals is to take out just 4 percent of your portfolio in the first year, then adjust that amount in future years. “That’s still a safe starting point,” says Ward.

For those with strong budget discipline, however, you may be able to pull out more income with a flexible spending approach. Research (PDF) by Guyton and William Klinger, a professor at Raritan Valley Community College, found that by following basic “guardrails”—rules that limit your spending after big market swings—retirees can avoid running out of money over three or more decades, despite bear markets.

To implement this strategy, you may need to skip an inflation adjustment in years following market drops, or even cut your withdrawals by 10 percent. This approach allows retirees to start with a withdrawal rate of 4.6 percent or more, assuming an allocation to stocks of at least 50 percent, Guyton and Klinger found.

Consider Guaranteed Income

In a shaky market, it helps to have a steady stream of guaranteed income to help cover your essential costs. For most retirees, Social Security can provide some of this income stream—for a single person, the average Social Security payment is about $1,400 a month.

To make the most of your benefit, be sure to choose the right claiming strategy, says Steve Vernon, author of "Retirement Game-Changers" and a research scholar at the Stanford Center on Longevity. Each year you wait to file, your payment increases until maxing out at age 70. (To find out your benefit at different ages, go to mySocialSecurity.gov.)

If you want more guaranteed income, consider using a slice of your retirement savings to buy a single premium immediate annuity, says Vernon. With this type of annuity, you put down a lump sum and receive a monthly payment for the rest of your life. You can get estimates of payouts for different amounts at immediateannuities.com.

Before making this move, however, it may be helpful to consult a fee-only certified financial planner, who can assess your retirement income strategy. Some planners will provide a one-time review for a flat fee. (For tips on choosing a financial planner, see our stories here and here.) “Having an expert in your corner, especially in a down market, can be big help,” says Pfau.

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