7 Ways to Manage Retirement Savings in Rough Times

January 16, 2023 Mark Riepe
Now is a good time to reassess your risk tolerance, your goals, and the quality and structure of your portfolio.

Market volatility has increased over the past year, as investors keep a wary eye on inflation, interest rates and geopolitical uncertainty. While not fun for anyone, market downturns can be particularly uncomfortable if you're an investor transitioning into retirement (typically ages 55 to 70). Unlike a younger investor who has decades to recover from a market downturn, you may worry that you don't have long enough. Also, if you're withdrawing money from your investment portfolio, you may be forced to sell stock at depressed prices to fund living expenses.

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. In this spirit, we've compiled a "top 7" list of actions that could help to buffer your portfolio and increase your comfort level so that you're better able to ride out the current turmoil.

1. Reassess your willingness to withstand volatility

It's a good idea 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 studies1,2 have shown that the risk tolerance of individuals is influenced by recent market activity: When the market goes up, people want to take risk; when it goes down, they 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

Capacity refers to whether your financial situation allows you 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 or investors who need money from investments soon have less time to make up for any losses and so it makes sense for them to be less aggressive. As a rule of thumb, we believe equities shouldn't be more than 60% of a pre-retired/early retired investor's portfolio (roughly ages 60 to 69) for investors who plan to use their portfolio primarily to support themselves in retirement rather than legacy goals, with that percentage likely declining over time. Below are some hypothetical portfolios illustrating how an asset allocation could become more conservative throughout retirement. Your risk capacity might be lower depending on the amount of annual spending you desire compared to the size of your portfolio; on the other hand, if you have a very large portfolio with small annual expenditures, you can likely afford to take on more risk.

Your risk profile may begin to change near and throughout retirement

Pie charts show potential asset allocation targets for portfolios with risk profiles that are moderate, moderately conservative and conservative.

Source: Schwab Center for Financial Research

Although it's generally recommended that you shift to a more conservative investing approach during retirement, your asset allocation still depends on your own circumstances and tolerance for risk. For illustrative purposes only.

3. Use a "bucket" approach

No matter the market conditions, we recommend that people in retirement hold the equivalent of a least a year's worth of anticipated withdrawals in cash investments—such as checking or savings accounts, money market funds, or certificates of deposit (CDs) maturing in less than one year—with another two to four years' worth anticipated future withdrawals in relatively liquid, conservative investments such as short-term Treasuries and other high-quality bonds or short-term bond funds. That way, in the event of a long bear market, you can use those short-term bonds as cash to help meet your spending needs, instead of selling stocks or longer-term bonds at depressed prices. A four-year cushion is generally enough to help you weather most bear markets.

This is particularly important during the early years of retirement because of a phenomenon known as "sequence of returns" risk. That's the risk that a major price drop in the beginning of retirement may force an investor to sell more investments to raise a set amount of cash for living expenses. This not only drains savings, but leaves the portfolio with fewer assets to generate potential growth during the remainder of what could be a 25- or 30-year retirement. By contrast, the same price drop later in retirement tends to cause less damage to a portfolio's total performance.

4. Understand the risks associated with cash

It may feel tempting to flee the equity markets altogether for the safety of cash investments, but a cash-heavy portfolio has its own set of risks. History has shown that cash investments simply have not done very well in terms of long-term returns compared with other asset classes. A typical 60-year-old may need to draw on a portfolio for another 25 years or more, and will need a growth component in the portfolio to account for the fact that cash and short-term fixed income investments have difficulty keeping up with inflation. 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).

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 it. For example, we've suggested, as a rule of thumb, that you can withdraw 4% from your portfolio in the first year of a 30-year retirement, 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 and others criticize it for being too high. Our view is that no rule of thumb is perfect. It's a useful starting point that you can then adjust to accommodate your own circumstances. It's also important to understand that your circumstances change and your portfolio withdrawal amount should change with them. Ultimately you need to understand that the more money you withdraw reduces the longevity of the portfolio especially when you withdraw when market returns have been poor. On the other hand, withdrawing only small amounts makes it more difficult to live your life—which is, after all, the reason you've saved for retirement in the first place. This is where planning  becomes so important. It gives you an opportunity to do the analysis and balance the tradeoffs.

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 moreso in tough market environments as investors collectively seek out safe havens.

Also keep in mind that if you sell a security held in a taxable account and realize a loss you can potentially use that loss to offset income or realized gains, an action known as "tax-loss harvesting." You can use the loss to reduce your capital gains and potentially offset up to $3,000 of your ordinary income. The general principle behind tax-loss harvesting is fairly straightforward, but there are a few things to keep in mind. For one, tax-loss harvesting isn't useful in retirement accounts, such as a 401(k) or an individual retirement account (IRA), because you can't deduct the losses generated in a tax-deferred account. Also, you should be careful not to run afoul of the wash-sale rule, which prohibits selling a security at a loss and buying the same or a "substantially identical" security within 30 days before or after the sale. If you do so, the loss is typically disallowed for current income tax purposes.

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 tend to 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.

1 Imas, A., "The Realization Effect: Risk-Taking After Realized Versus Paper Losses," American Economic Review, Vol. 106, No. 8, August 2016.

2 Rabbani, A., et al., "Stock Market Volatility and Changes in Financial Risk Tolerance During the Great Recession," Journal of Financial Counseling and Planning, Volume 28, Number 1, 2017.

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