It’s Murphy’s Law of every retirement plan.
The market tanks the last few years before your retirement. Or worse, it crashes the day you retire, leaving you less money to generate the income you need as you begin taking money out to live.
As the market hits a new period of volatility, more people ask me about how investors can protect themselves from market gyrations as they approach retirement. With the record-setting downdrafts in the market, fear is over-taking greed and investors are worried.
And in their worry they reveal one of the fundamental flaws of most investment individual strategies: Most investment strategies revolve around selecting the proper asset classes that should be in a portfolio—cash, bonds, US stocks, metals, foreign stocks, etc. But they ignore the real purpose of most investments plans: Someday it will need to provide investors with the cash flow needed to live.
The primary focus of an investment plan, even for the very young, should be to provide cash flow for the investor when the investor needs it. So if an investor must ask the “What if the market crashes today” question about retirement, then they don’t have a very good plan or the planner hasn’t communicated well.
Both are causes for worry.
The good news is that making your portfolio “crash proof” really doesn’t require radically different investment options than most investors are currently using. It just requires investors to ask this question before they move money in their plan: “When will I need this money?”
Because to make your portfolio “crash proof” requires you to make certain that every year you can withdraw the cash you need to live without touching principle.
How do you do this?
Investors should segment their assets to provide cash flow, not just investment return. Often called a Bucket Strategy, investors invest in assets based on when they will provide stable cash flow, rather than thinking just about total return.
Simply put, investments are allocated into three buckets.
Bucket one is the cash you need for one year.
Bucket two is the cash you need for years 2-5.
Bucket three is the cash you need for years six and beyond.
In practice, it’s a bit more complicated than just three “buckets,” but the concept helps investors to start thinking about their portfolios as an ATM rather than a casino.
If done properly, the strategy should not effect total return, but rather add some security to your portfolio. The best part, is that is if the market sells off radically, investors are certain that they can hold on to principle as the market begins to recover.
For sophisticated investors, it means that they can buy low, rather than sell low.
In the old days, investors used to just cut back on their stock portfolio as they approached retirement and add some fixed income type investments, like bonds, to cover cash flow needs. But in an interest rate environment that is historically low, and with the market seeing increased volatility to the upside and the downside, it’s becoming more important to take into account when you will be withdrawing money from your plan.
All things being equal, there are real lifestyle differences between the guy who must start to withdraw cash in a down market versus someone who can withdraw cash in an up market.
Most financial planning tools frankly don’t ask those hypothetical questions about what the market will do on day one or year one of someone’s retirement. They just add a flat-lined fixed rate of market return that compounds annually, which is not how the markets—and life—work.
For too long, retirees have been hostage to the vagaries of the market because the financial planning community is a little lazy and a little crowded with inexperienced planners who save their imagination for those things that provide the best commission.
Find out more about about how to turn your plan into an ATM by asking your financial planner how to provide the cash flow you need for retirement. If your planner can’t answer well, find a new planner.
If you have questions about money, retirement, real estate, cars, mortgages and more, send them to me.