Life’s been good for most people the past several years since the major mortgage crisis hit the country. The country responded and slowly recovered to a solid and stable economy in most parts of the country. But if you listen to the experts, everything is cyclical…which means we are getting closer to the end of this economic cycle. When this happens, we usually experience a slowdown in the economy which can trigger a minor or major recession.
Whether or not you subscribe to this thinking or not, it is important to take precautions to protect what you have worked so hard for over the past decades. Now is not the time to be foolish or take risks but to be prepared if a slowdown occurs. Given the past nature of these slowdowns, it is definitely worth taking precautions to protect your nest egg.
Many experts are saying that we are due for a correction that trims 20% or more from current stock values. That could be a big problem for anyone who needs to take required withdrawals from investment portfolios, according to this article “How to reset retirement plans to weather a downturn,” from the Associated Press.
It’s a challenge since the market has quadrupled since 2009, when the recovery from 2008 got underway. Returns on bonds and cash still remain low. If you haven’t taken steps to rebalance your portfolio in a while, it’s likely you may have a high degree of exposure with your current balance of equities.
Now is a great time to undertake some rebalancing activities with your portfolio. This should always be started before markets begin any roller coaster rides and rational thinking tends to go out the window. The proper asset allocation depends on your income needs and your risk tolerance. Financial planners advise people to have a few years’ worth of withdrawals in safer, low-risk investments, so they are not asking to sell everything when markets adjust.
One planner has his clients keep one to three years’ worth of expenses in case, plus seven to nine years’ worth in bonds. As a result, they have 10 years before they need to sell in the event of a correction. Since most cycles last only a few years, this is a pretty good timeline to plan for these potential events. If you can plan for a ten year cycle, many experts say this should help you protect your portfolio.
While it might seem obvious, you never want to sell into a correction. However, many people panic and do just exactly that without prior planning. The key is to plan on the economic correction and make plans while we are still in a strong or stable economy so you (and your financial advisor) can make the most prudent decisions on your behalf.
Some advisors are sticking with what is known as the 4% rule. This rule says that retirees can minimize their risks by withdrawing 4% of their portfolios in the first year of retirement and increasing the amount in subsequent years by the inflation rate. Many think this rule will not work in an environment of low returns. Regardless of whether or not you subscribe to this rule or not, it is at least something to discuss with your advisor and get their perspective on the advantages and disadvantages.
Still yet another approach is to completely forgo inflation adjustments in bad years. If you start at a 4.5% withdrawal rate and then trim spending when portfolios lose money, this may be more flexible you and your investments.
Regardless of the approach you decide to follow, reducing expenses and maximizing Social Security benefits is always a smart approach for retirees. The more guaranteed income you have the less risk you need to take in your investments. Keeping your risk to a minimum during retirement is critically important so as not to lose your principal foundation.
Retirees, in a perfect world, would have all the money they need based on their own investments, retirement accounts, and Social Security. However, if they don’t have enough income, they can create more income by purchasing a fixed annuity or tapping the equity in their home through a reverse mortgage or other such instruments.
In this situation, buyers pay a lump sum to the insurance company for a fixed annuity and then receive a fixed monthly amount that can last a lifetime. A reverse mortgage essentially gives homeowners access to the equity in their home, which does not need to be paid back until the owner sells, dies or moves. Since there are costs and restrictions on both these investment strategies, it would be wise to do your homework before embarking on either one.
The key is to be prepared. Do your planning early and involve a team of professionals. This team is more than your investment advisor. It should include your estate planning attorney and your accountant. When the team understands where you are and where you want to go and in what time frame they can build a plan that helps you prepare for both good and not so good market conditions.