Some Advice For Market Corrections

Yes, we’re due for a correction that trims from stock values. That could be a big problem for people taking withdrawals from investment portfolios, since market losses early in retirement increase the chances of running short of money.

The answer isn’t to cower in fear, but to plan for the inevitable downturns. Financial planners say the following actions can help make your money last.

Stocks have quadrupled since March 9, 2009, the beginning of the current bull market. Meanwhile, returns on bonds and cash remain low. Investors who haven’t regularly rebalanced back to a target mix of stocks, bonds and cash probably have way too much of their portfolios in stocks.

The time to rebalance is now, before markets start bucking and making it harder to think rationally. The right asset allocation depends on your income needs and risk tolerance, among other factors, but many financial planners recommend having a few years’ worth of withdrawals in safer investments to mitigate the urge to sell when stocks fall. This is where are firm shines. We help manage risk and growth in your portfolio.

Planner Lawrence Heller of Melville, New York, uses the “bucket” strategy to avoid selling in down markets. Heller typically has clients keep one to three years’ worth of expenses in cash, plus seven to nine years’ worth in bonds, giving them 10 years before they would have to sell any stocks.

“That should be enough time to ride out a correction,” Heller says.

Historically, retirees could minimize the risk of running out of money by withdrawing 4% of their portfolios in the first year of retirement and increasing the withdrawal amount by the inflation rate each year after that. This approach became known as the “4% rule.”

Some researchers worry that the rule might not work in extended periods of low returns. One alternative is to start withdrawals at about 3%.

Another approach is to forgo inflation adjustments in bad years. Derek Tharp, a researcher with financial planning site Kitces.com, found that retirees could start at an initial 4.5% withdrawal rate if they were willing to trim their spending by 3% — which is equivalent to the average inflation adjustment — after years when their portfolios do not perform well.

“You don’t actually cut your spending. You just don’t increase it for inflation,” says financial planner Michael Kitces.

Reducing expenses trims the amount that retirees must take from their portfolios during down markets. That’s why Melissa Sotudeh, a financial planner in Rockville, Maryland, recommends paying off debt before retirement.

She also suggests clients maximize Social Security checks. Benefits increase by about 7-8% for each year people put off starting Social Security after age 62. The more guaranteed income people have, the less they may have to lean on their portfolios.

Ideally, retirees would have enough guaranteed income from Social Security and pensions to cover all of their basic expenses, such as housing, food, utilities, transportation, taxes and insurance, says Wade Pfau, professor of retirement income at the American College of Financial Services. If they don’t, they may be able to create more guaranteed income using fixed annuities or reverse mortgages, says Pfau, author of “How Much Can I Spend in Retirement?” We advise causation when it comes to reverse mortgages. They can be a very costly way to receive income.

Fixed annuities allow buyers to pay a lump sum to an insurance company typically in exchange for monthly payments that can last a lifetime. Reverse mortgages give people age 62 and older access to their equity through lump sums, lines of credit or monthly payments, and the borrowed money doesn’t have to be paid back until the owner sells, dies or moves out.

Also see: Are you and your retirement funds ready for the next recession?

Covering expenses with guaranteed income actually can free retirees to take more risk with their investment portfolios, which over time can give them better returns and more money to spend or leave to their kids, Pfau says.

“They’ll be able to invest more aggressively and still sleep at night because they don’t need that money to fund their day-to-day retirement expenses,” he says.

 

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Securities offered through BB Graham & Company a Registered Broker/Dealer, member FINRA/SIPC. Principal Planning Service, Inc. is not affiliated with BB Graham & Co."