What happens in the first decade of retirement can predict upto 80% of your retirement income plan outcomes.How to optimise especially for market downturns.
By Anna B. Wroblewska.
You've researched Medicare, thought about your Social Security plan, and packed the RV. But you might be reading the news and looking at your retirement portfolio with a great deal of uncertainty. How do you know if your assets can weather the current -- and any future -- downturns and storms? Can you really take the plunge now?
Research has shown that what happens in the first decade of retirement can predict 80% of your retirement income plan outcomes, so your concerns are certainly well justified. However, it can be all to easy to get caught up in analysis paralysis. Rather than letting the news worry you into inaction, take the bull (or bear) by the horns and find out what you can do to plan ahead and make the most of any environment.
The critical first decade
Why is the first decade of retirement so important? The outsize effects of the early years is a result of "sequence risk," or the outsize effect that timing has on long-term portfolio returns.
If you experience a big downturn early in retirement, you not only have the initial problem of a lower account balance, but you also compound the issue with potential withdrawals. In a way, you're locking in poor performance when you have to draw down on a struggling account.
Both equity swings and low bond yields can affect your retirement income planning. The stock market provides a more obvious example, as many investors are familiar with the shortness of breath that comes from reading account statements during market downturns. You might even have recent experience with the phenomenon, considering that the market just had its worst quarter in four years!
However, bond yields can be similarly stressful: when you're counting on bond income to provide for your retirement cost of living, a low-yield environment effectively takes the wind out of your sails. This is made worse by the incredible persistence of bond yields. Studies have found that low yield environments can persist for a decade, meaning that the current environment could continue for quite some time.
What can I do?
A poor market environment doesn't mean you need to put off your retirement indefinitely or worry about whether you can survive in the long run. While you could experience repercussions in your portfolio for quite some time, you can take action minimizing your exposure, adjusting for the hard times, and keeping a tight lid on costs.
To meet these goals, consider taking the following steps:
Continue to invest
While down markets have a tendency to scare people off, they're actually the best time to buy. Of course, as a pre- or near-retiree, you'll want to avoid putting all your eggs in one basket or reallocating your whole portfolio to equities, but do continue to take calculated risks in a prudent manner. If you have a dollar-cost averaging strategy, in which you regularly invest in the stock market, keep going. Continue to allocate to your equity holdings and you'll provide yourself with the potential to move back up with the market in coming years.
How much? Most people know that equities are not a popular destination for retirement-income portfolios because of the risks. However, recent research has indicated that this approach tends to be counter-productive. One study suggested that retirement portfolios performed best with 60% allocated to equities -- regardless of market environment!
Of course, what you invest in is just as important as the overall allocation. To that end, bear in mind that the very worst thing you can do to your retirement account is pay more than you need to: so stick by your strategy instead of trading in and out, and find the lowest-cost way of allocating your funds.
Both of these actions will go a long way towards keeping you on track in the coming decades no matter what the market brings. Low-cost index funds are portfolio Old Faithfuls for a reason -- stay away from the marketing-heavy actively managed funds and get the most bang for your buck instead.
Alternative income sources
Next, to deal with low yields and poor performance, consider developing alternative income streams. These will help you to keep your portfolio intact so that it has more opportunity to bounce back in the future.
How else can you finance your golden years? Consider all the other assets and talents you might have on hand -- rental property, a defined benefit pension, annuities, or even a part time job can provide a level of steadiness and stability to counteract the movements in your retirement account. Having alternatives, even if it's just a few months' worth of cash in the bank, can not only keep your portfolio safer, it can go a long way towards helping you sleep at night when the going gets tough.
Take a dynamic approach
Finally and similarly, when it comes to drawing down on your portfolio, try to be dynamic instead of adhering to simplistic rules. Concepts like the "4% rule," in which you take an annual income equal to 4% of your first retirement year's account balance, are very attractive for their user-friendliness, but they can put you under unnecessary pressure in the critical first decade.
If markets are down and yields are low, you want to minimize the impact by drawing as little as possible. To make it work, try to focus on living from alternative income sources, as mentioned, or consider downshifting your living expenses to stay flexible.
Of course, some people run the numbers and decide that postponing retirement is a good idea. The decision really comes down to your asset levels, reliance on retirement accounts, and appetite for risk over the long run. For example, while allocating more heavily to equities might make sense on an analytical level, it can also cause a lot of tension if it doesn't suit you personally. At the end of the day, if these tactics don't seem sufficient to keep you reasonably secure in retirement, you very well may want to consider postponing.
Whatever you decide, keep a strong focus on getting the very most out of the first decade of retirement. You can't choose the market conditions you're facing, but you can choose your response: make sure it's the best one you can muster.
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