7 Ways to Take Control of Your Retirement in Rough Times

Updated March 2, 2009

Mark W. Riepe
CFA, Senior Vice President, Schwab Center for Financial Research

If you're like many investors, this is the first time you are experiencing a period of extended market volatility. But it isn't just the big swings in market averages that have investors spooked. Many portfolios have lost large amounts of money. Disturbing news events occur on an almost daily basis. Many of these events are unique—at least in recent history. What's worse, there's a concern that a lifetime of work intended to culminate in a pleasant retirement is now threatened. 

When confronted with the unfamiliar and the uncomfortable, a natural reaction is fear, then the desire to take action as quickly as possible—action designed to reduce that fear. Although this reaction is understandable, we believe that you can take more concrete and constructive steps to improve your footing.

Although you can't control the markets (no one can) and predicting their short-term direction is impossible, it's important to focus on the things you can control.

In this spirit, we've provided a "top 7" list below targeted toward investors who are in or near retirement. The intent is to provide a list of concrete actions that you can consider taking right now that could improve your portfolio and increase your comfort level so that you're situated correctly to ride out the current turmoil. This is not a comprehensive list, but we think they are particularly appropriate right now.

1. Reassess your willingness to withstand volatility. One characteristic of successful investors is their ability to strive for higher returns while tempering that pursuit with considerations of risk. A best practice is to assess your willingness to tolerate risk during a "neutral" market (in other words, one that is not swinging too high or too low). This is because studies show the risk tolerance of individuals is influenced by recent market activity. When the market goes up, people want to take risk. When the market goes down, people want to avoid risk. Having said that, there's no better teacher than the real world to help you gauge your true risk tolerance. If your portfolio is calibrated to a level of risk that makes it hard for you to sleep, then consider selecting a portfolio with a risk level more appropriate for you.
   
2. Reassess your capacity to withstand risk. Risk tolerance is often thought of as being a purely psychological characteristic (in other words, "How much do big swings in the value of our portfolio bother us?"). Capacity is another dimension of risk tolerance. Capacity refers to whether our financial situation allows us to take risks. For example, younger investors are generally encouraged to be more aggressive because they have decades to make up any losses. Older investors have less time to make up for any losses and so it makes sense for them to be less aggressive. We believe equities shouldn't be more than 60% of an older investor's portfolio, with 40% as a good rule of thumb for the percentage on the date you start taking withdrawals. This percentage should decline over time. Your capacity might be lower depending on the amount of annual spending you desire compared to the size of your portfolio. For example, very large portfolios where annual spending from the portfolio is small can afford to take on more risk.
   
3. Understand the risks associated with cash. Right now, a natural inclination is to flee the equity markets for the safety of cash investments (from an investor's perspective, this category usually includes vehicles like money market funds, Treasury bills, and other traditionally safer, short-term investments). There's nothing wrong with cash investments for part of your portfolio. We have cash investments in all of our model portfolios and have done so for years. In fact, a large cash investment position makes sense for those with short time horizons. We get concerned, though, when individuals reassess their tolerance for volatility (just one aspect of risk) and neglect to consider that cash-heavy portfolios have their own set of risks. Cash-heavy portfolios typically tend to be less volatile, but we believe they also have poor, long-term return prospects. For example, money market funds that invest in short-term Treasury securities are popular right now. These might have a yield near 0%. This relatively lower rate of return on cash investments is something of an anomaly owing to the fact that the Federal Reserve has been keeping interest rates low as an economic stimulus measure. Nevertheless, history has shown that cash investments simply have not done very well in terms of long-term returns compared with other asset classes. Consider your longer-term objectives for investing in the first place, including your tolerance for risk, and see whether a cash-heavy portfolio is likely to achieve them. For example, a 65-year-old has a life expectancy of 19 years. See the table below for life expectancies broken down by different ages and whether one is male or female.
   
4. Revisit the goals for your portfolio and structure it accordingly. Investing is a means to an end, not an end unto itself. Your strategy depends on how you ultimately plan on using the proceeds from your portfolio. As an example, let's consider a retired couple in their early 60s. They have short-term spending needs and for that purpose, they use Social Security for some of that spending and rely on their portfolio for the rest. While they have short-term needs, they also recognize that a typical individual in his or her early 60s may well need to draw on that portfolio for another 25 years or so. They need a growth component in the portfolio to account for the fact that fixed income investments, (particularly short-term fixed income investments) have difficulty keeping up with inflation. Set aside enough cash to cover your routine expenses for one year (minus what you expect from reliable nonportfolio sources of income, such as Social Security). Allocate the rest of the portfolio using one of our asset allocation model portfolios. Pick the model portfolio that matches up with your time horizon (in other words, how long you'll be investing and your willingness to bear short-term volatility). A good practice is to keep an additional two years' worth of portfolio spending in high-quality, short-term instruments as part of your fixed-income allocation. That way, in the event of a long bear market, you can use those short-term bonds as cash to help fulfill your spending needs instead of selling stocks or longer-term bonds at the worst possible time. The one-year spending reserve plus the two years' worth of short-term bonds in the portfolio itself are more likely to remain stable, making it easier for you to ride out short-term stock market fluctuations.
   
5. Revisit your cash-flow needs. If your portfolio is an important source of income for you, then it's important to revisit the amount of money that you are withdrawing from the portfolio. For example, we've suggested, as a rule of thumb, that you can withdraw 4% from your portfolio, increase that amount by the rate of inflation, and have an excellent chance of the portfolio lasting for 30 years. That 4% figure is sometimes criticized for being too low. The reason it may seem low is that the figure was set low enough in order to accommodate markets like the one we're currently experiencing. Are you withdrawing more than 4% of your portfolio's value to live on currently? No one can control what the stock market does, but you have far more control over the spending rate from the portfolio. In light of the turbulent situation, make sure you understand your spending levels, as well as your portfolio value. Withdrawing large amounts from your portfolio during down periods can permanently impair the ability of the portfolio to recover when prices rise again.
   
6. Check the quality of your holdings. The first five steps are about overall portfolio strategy, but now's a particularly opportune time to review your specific holdings, as well. Holding securities (for example, stocks, bonds, and mutual funds) with poor prospects for the future is always a poor strategy, but is seemingly punished more so in tough market environments as investors collectively seek out safe havens.
   
7. Check your portfolio concentration. Portfolios that are highly concentrated in a handful of securities are always troublesome from the standpoint of risk management, but especially so in a fear-driven market. One characteristic of a fear-driven market is that investors react with a "sell first and ask questions later" mentality to every rumor about every security. What this means to you is that any single holding you may own can be subject to a big downward movement even if the company is fundamentally sound. Review every holding in your portfolio. Ask yourself, "What if something bad happens to that stock, bond, or mutual fund?" If potential losses (even temporary ones) on a single security will cause you undue hardship, then you probably have too much exposure to that security. Regardless of the security's quality, consider selling some of it and invest the proceeds elsewhere. Note that we are not just talking about equities and mutual funds. Individual bonds can be risky, as well. Make sure the fixed income portion of your portfolio is well diversified across different types of issuers.

Note: Table values denominated in years.
Source: Table A from "United States Life Tables 2004," National Vital Statistics Reports, volume 56, number 9, December 28, 2007.