In our January blog post, we explored the question of when to retire—more specifically, the portfolio implications of retiring at what could be the beginning of a bear market. In light of recent volatility in public markets and anticipation of a long overdue downturn, sequencing risk is of particular interest to clients approaching or considering retirement—and understandably so.

For those who cannot or don’t want to wait to retire under more favorable market conditions, there are specific strategies we recommend for mitigating sequencing risk. These contingency plans help us to focus on those things we can control and to feel more confident in our preparation. Before cracking that nest egg, we suggest you consider:

Retirement Buckets

A distribution or “bucket” strategy provides short-term certainty without sacrificing long-term security by divvying up your retirement funds into buckets that differ in asset type, purpose, and time frame. For example, you might create three buckets as follows:

• Cash (or cash equivalents) to be used for the upcoming year or two of expenses. This provides a regular source of cash without feeling pressured to liquidate other investments at an inopportune time; instead, those assets can stay invested while waiting for the market to rally.
• Bonds and fixed-income investments, which are less prone than stocks to suffer significant market downturn. A properly structured bond portfolio can serve as a well-defined annual source of investment income to help replenish Bucket 1 if needed.
• Stocks (or other equity investments) to sustain the nest egg for the long term. When market performance exceeds expectations, the excess appreciation can be used to replenish Buckets 1 and 2 if needed. On the other hand, when performance disappoints, Buckets 1 and 2 carry you through without having to sell stocks at a point of lower (or no) returns, providing critical peace of mind to stay the course and ride out market volatility.

Flexible Budgets

Spending needs change over time, and the same is true during retirement. Perhaps you hope to enjoy lower budgetary needs now that the kids are grown; perhaps your medical costs will unexpectedly rise in the years to come; or perhaps you hope to celebrate your freedom with an extravagant trip abroad.

We strongly encourage all our clients – not just those facing possible sequencing risk – to take a hard look at how they currently spend their money, set honest expectations around how those budgetary needs might change (for better or worse) during retirement, and quantify the cash flow realistically needed to retire. During this exercise, build in flexibility by identifying any items which might be postponed or eliminated should the market turn (for example, that trip abroad can probably wait, while medical expenses probably can’t).

Additionally, withdrawing a percentage of your retirement funds each year – rather than a fixed amount – further mitigates sequencing risk by reducing the impact of your withdrawals on top of the impact of lower returns. However, this strategy requires that you be able to live within a spending range that might fluctuate from one year to the next based on market performance, rather than adhering to a fixed annual budget.

Withdrawal Sequencing

Be thoughtful when prioritizing accounts for withdrawals. While fulfilling your Required Minimum Distribution amounts from your IRA or 401(k) comes first, consider following with more tax efficient non-taxable withdrawals from an HSA or Roth account.  Individual situations may vary, so be sure to work with a tax advisor to optimize the impact on your tax liabilities.

Buffer Asset Inventory

Take stock of any assets you may have that can be used, if necessary, to buffer cashflow shortfalls during a market downturn. Consider the cash surrender value of a life insurance policy, or selling that rarely used lake house. Despite the negative reputation of reverse mortgages, there are situations in which even these can be effective tools for supplementing retirement income.

Of course, you may choose to employ one, two, or all of these mitigating strategies to best prepare yourself for retirement, even if the market’s timeline doesn’t seem to align with yours. When in doubt, always seek the advice of a professional who can help you weigh your options and develop a thoughtful, well-rounded retirement plan that ensures you spend those golden years focused on filling the soul, not the coffers.

Suzanne T. Mestayer

For disclosures, please click here.

Retirement: it’s a phase of life many look forward to, but it’s also one of the hardest to plan.  Sure, there’s the question of how much, often referred to as your “number”—the amount of savings you’d need to be able to comfortably retire. Conventional wisdom has long relied on the “4% Rule” to help hopeful retirees calculate this number: the annual income you want or need throughout retirement (not including Social Security income) should represent 4% of your total savings upon retirement. So, if you’re targeting $150,000 in annual retirement income, you’ll need $3.75 million saved the day you retire.

While this rule of thumb may be helpful in its simplicity, that simplicity can leave many ill-prepared for the financial realities of retirement.

While the 4% Rule asks how much, it doesn’t ask how long. The 4% Rule assumes a 30-year retirement. If you don’t expect to live that long, perhaps you don’t need the full $3.75 million. Then again, if you midjudge your longevity, you could deplete your savings years too soon.

The 4% also doesn’t ask how you expect to live during retirement. In our experience, clients often underestimate how much their current lifestyle really costs, while they overestimate their ability to remain healthy and independent as they age.

Perhaps most importantly in our current market, the 4% Rule fails to ask when.

And when it comes to retirement, it’s not just a question of how big your nest egg is. It’s also a question of when you crack it.

Let’s suppose for a moment that you’ve worked to accurately quantify your retirement needs. You’ve even built in some you wiggle-room for unexpected expenditures. You feel confident in your $3.75 million nest egg number, and you plan to withdraw $150,000 a year. So long as the market is able to return 5% on your investments, your calculations tell you you’re headed for a long, financially secure retirement.

However, in your second year of retirement, the market takes a significant downturn. Suddenly, instead of the 5% return on your investment you’d planned for, your portfolio is now yielding a -12% return rate, as you continue to make withdrawals. After several years, the market rallies, and over the course of your entire retirement, your portfolio still manages to average 5% returns over time. However, averages can be deceiving.

Thanks to that drop in the market early in your retirement, you ate into your nest egg at a faster rate than anticipated, meaning any future market gains were made on a smaller egg. The earlier in your retirement you face a bear market – or worse, a recession – the more magnified is its negative impact and the harder it is for your savings to rebound. This is known as sequencing risk, and it’s of particular concern to those looking to retire just as the market prepares for a downturn.

The fourth quarter of 2018 was certainly such a downturn, and there continue to be predictions of a deeper bear market and possibly a recession.  And while it’s unclear if or when these predictions will come true, those approaching retirement must consider if, when, and how to do so in the face of such uncertainty. Some may decide to continue working to provide extra cushion for their nest egg.   For those who cannot or don’t want to wait, there are specific strategies we recommend for mitigating sequencing risk, including asset allocation strategies, distribution or “bucket” strategies, and flexible spending strategies. These contingency plans will be explored in subsequent blog posts; please stay tuned.

Suzanne T. Mestayer

For disclosures, please click here.