Are you ready for the next stock market correction? If not, you may be tempted to panic, which can be especially dangerous for retirees.
That’s because seeing red in your investment portfolio can lead to heightened emotions and stress, which can lead to poor investment decisions. When you sell during a downturn, you not only lock in losses but also leverage your portfolio to take advantage of market recoveries. Retirees can use a simple “fire drill” to test whether they can withstand a correction long before it happens.
Why retirees need a different type of market plan
No long-term investor likes it when the stock market drops, but it can be a particularly scary time for retirees who need to withdraw from their portfolios to pay for living expenses. Retirees don’t have a steady paycheck to help with ongoing expenses.
They also face a special type of risk known as return sequence risk, which is the risk that a market correction before retirement may require the retiree to sell more investments to generate cash, leaving them with a smaller nest egg in retirement. It will take a long time to recover what they have lost as they have to continue to withdraw to meet the cost of living, and that can force some people to live on less money or to work part-time.
It is important to know how much risk you can tolerate and how much money you should have on hand.
How to manage retirement portfolio firefighting
The first step in the exercise is to review your current portfolio mix to see how well you have allocated money across stocks, bonds, cash and other assets. Then, check the reasoning. For example, consider how your portfolio and withdrawal strategy might change if your stock portfolio loses 20% or 30% of its value.
In that case, it’s good to have a large savings account that can cover monthly living expenses, so you don’t have to withdraw too much from your portfolio. Sources of income like Social Security, a pension or a gig job can also make you independent of portfolio withdrawals.
It’s also a good idea to review your portfolio’s concentration in certain sectors and stocks. Some investors rely heavily on one stock or industry, which can lead to more losses if their favorite stock or sector undergoes a significant correction.
This exercise also allows you to decide how to respond to this type of situation. Did you feel a sense of dread at the thought of a 30% drop, or did you feel confident in your ability to navigate that situation? Investors feeling nervous may want to rebalance their portfolios.
What you need to fix before the next sale
Trying to time the market is risky, especially for retirees who depend on their portfolios to cover their daily needs. You can rebalance your portfolio to build enough savings so you don’t sell the investment during a downturn. Assessing your sources of income and expenses will also help you determine the gaps you need to fill in your portfolio and savings.
Many financial advisors recommend that retirees save enough cash to cover one or two years of expenses. Then, you can invest in fixed income assets to meet short-term needs and growth-oriented assets like stocks to help ensure you don’t run out of money deep into retirement.
You should also plan how you will withdraw money from various retirement savings accounts to minimize your tax impact. Tax management is different for Roth plans, traditional plans and merchant accounts. A tax professional or financial planner can help you consolidate your deductions to minimize your taxes.
