In an earlier post we discussed how to cope with market volatility while investing for retirement. The financial part of this answer is straightforward, but dealing with the emotional aspect is hard.
One of the advantages of working for a paycheck is that you’re able to buy investments from your pay. If the market goes down, then you buy more investments. As Warren Buffett says, “A short quiz: If you plan to eat hamburgers throughout your life… should you wish for higher or lower prices for beef?”
In retirement, you’re not bringing home a paycheck anymore: your assets have to supply your income. Not only that, but they have to grow so that your income rises with inflation, or you must have enough assets that you can’t outlive the principal. If the market goes down then the size of your investment portfolio usually drops with it. Even worse, your income may drop too.
In the earlier post I mentioned that spouse and I have experienced extreme volatility three times: twice while we were working and once in retirement. We survived all three in better financial condition than we started them, but the third experience had a new emotional impact that changed our views on market volatility during retirement. We’ve also had experiences with other family members that changed our perception on how to manage their finances too.
However this really isn’t about spouse & me or our investments. It’s about the different choices to be made during the “distribution” phase of managing a retirement portfolio. Talking about our portfolio is just a way to offer specific examples.
We survived the 2008-09 recession without cutting our spending. Today our retirement portfolio is back ahead of our “needs”. We’re still 20% below the ridiculous highs of 2007, but we have enough money to live our beach-bum surfer-dude lifestyle for the rest of our days. We also know that we can handle some volatility, so for now we’re staying with our four stock asset classes and we’re not investing our retirement money in bonds. Our military pensions are the equivalent of bonds, so we usually keep over 90% of our retirement portfolio in stocks.
One of the reasons we’re still so aggressive in our investing is that we reduced our expenses over the last three years– we refinanced our home mortgage and dropped our payments by over 25%. We’ll play much better defense in the next bear market. We won’t have to tap into our TSP and Roth IRAs anytime soon so they can grow tax-deferred indefinitely, helping us self-insure for long-term care. We might make our daughter a very happy heiress in 50 or 60 years, or we could give it away to charity. Or we could have one heck of a world cruise.
However since the Great Recession we also don’t hesitate to “take a little off the table”. When one of our four stock asset classes gets to be more than 25% of our portfolio, we’re selling it back down to 22% instead of seeing if it’ll shoot for 30%. If all four are heading for 25% then we might sell a little from one of the leaders to raise our cash to 10%, perhaps offsetting the capital gains by selling whatever other asset shares have lost some value. This is the equivalent of a worker doubling the size of their emergency fund in case of a layoff.
These days we don’t take any risk with our daughter’s college fund. (You’re welcome, honey!) We took substantial equity risks over 10 years ago, but as she got closer to high school her college fund moved more into cash. Today it’s in CDs, I bonds, and a few leftover 1990s EE bonds. She starts her sophomore year in a few months and we can’t mess around with that money, no matter how attractive the ZipCar IPO seems to be.
In our other generation, my father is expecting to spend the rest of his life in a long-term care facility. Those expenses average at least $75K/year and could easily rise by 10%/year. He still has pension income and long-term care insurance, but he can’t put up with much equity volatility. His retirement portfolio started 2011 at 85% stocks because he was living on his pension income and spending very little money. However this week he’s selling his Fidelity fund investments in Magellan and International Value to put the money in CDs. Both of his investments in those funds still have losses from 2008-09 so he’ll sell some of his other stock shares to offset the mutual fund’s losses with the stock’s capital gains. Over the next year or two (while he’s receiving funds from his long-term care insurance policy), his asset allocation will drop to 50% stocks and his cash allocation will rise to 30%. When his long-term care insurance runs out in a few years, he’ll be over 50% cash and 30% bonds. He’ll be able to ride out market surprises without having to worry about permanent losses.
Again, these are just examples of our choices. During the recession many early retirees did nothing at all– their diversified stock dividends dropped a bit but they had enough cash in savings to make up for the lower dividend income. Now that the markets are rising and companies are raising their dividends again, the investors are replenishing their cash savings. A few retirees have their retirement portfolio in balanced mutual funds like Vanguard’s Wellesley. Although the markets whipsawed both stocks and bonds, Wellesley managed to damp out the volatility and keep its distributions almost constant. Today it’s heading for new highs.
Some retirees continued to spend their portfolio income and even dipped into the principal, feeling comfortable that the market’s long-term averages would give their portfolios enough time to recover. Others cut back their spending or even thought about part-time employment.
I’m surprised at how much my attitude toward volatility has changed in the last few years. I’m still a very active investor but I did not enjoy having to look at the shrinking remains of our portfolio, let alone explain our performance to my spouse. Knowing what you have and forecasting what’s next is one thing– feeling good about it is quite different. If you’re reaching the end of your working years, then be ready for your own volatility tolerance to become more conservative. Reduce your asset allocation to stocks, or raise your allocation to cash, or even (if you’re not getting a pension) consider annuitizing a part of your income.
No matter what you decide to do, think through how you’ll feel and what you’ll want to do if your portfolio drops in value by 30%. It’ll help you get through the experience with a little less pain and a lot less panic.
If you went through the Great Recession as a retiree, how did you handle the volatility? Share your experiences in the comments. Thanks!
Retirement Income Redesigned: Master Plans for Distribution: An Adviser’s Guide for Funding Boomers’ Best Years
This 2006 book might be available through your local library. It’s a great series of articles on how financial advisers try to prepare their clients for retirement volatility. If you’re approaching retirement then it’ll give you more ideas on how to design your own distributions.
Asset allocation considerations for a military pension
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