How to Minimize Market Risk During Early Retirement Stages

The apprehension among retirees regarding the stability of their retirement funds has been heightened by the recent fluctuations in the market, and it is a valid concern. Unlike investors who are several years away from retirement and can afford the time needed for market corrections to be rectified, individuals who are approaching or are already in retirement find themselves lacking the advantage of time. However, there is no need for despair, as the following recommendations can aid in alleviating the risk associated with a market pullback during the early stages of retirement.

1. Maintain short-term and long-term investments

It is crucial to address a common misconception among retirees that, upon reaching retirement, they become exclusively short-term investors. While it is true that retirees rely on investments to cover their daily living expenses, it is important to recognize that retirement does not negate the need for long-term investments.

Retirees often have a lifespan of 20 to 30 years during retirement. If one were to retire at the age of 65 and allocate all investments solely to short-term vehicles, significant growth opportunities would be missed, while the impact of inflation could erode purchasing power over the following decades. Thus, it is imperative to construct a portfolio that caters to current lifestyle requirements while simultaneously maintaining focus on long-term goals that extend several decades into the future.

To achieve this objective, it is advisable to adopt a two-pronged approach:

• It is advisable to maintain a reserve equivalent to three to five years’ worth of living expenses in easily accessible, liquid investments with shorter-term maturity. It is recommended to consider a diversified combination of fixed income securities such as individual bonds or bond funds, which can serve as a source of capital for your monthly income needs.

In times of stock market volatility, having an allocation to bonds allows for the availability of funds that can be utilized to rebalance your investment portfolio, enabling the purchase of stocks at discounted prices. This strategy ensures that you take advantage of market downturns to enhance the overall performance of your portfolio.

Furthermore, incorporating a portion of your portfolio into short-term bonds serves as a buffer to accommodate regular or one-time distributions. In the event of a decline in the equity market, the ability to generate cash from the bond segment of your portfolio will help you avoid the need to sell stocks when their values are depressed, safeguarding your portfolio against adverse market conditions.

• It is recommended to allocate the majority of your retirement savings to a well-diversified portfolio, which should prioritize both growth potential and protection against inflation. While this allocation should align with your risk tolerance and investment objectives, it can include investments in riskier assets compared to your short-term investments. It’s crucial to keep in mind that if you intend for your portfolio to sustain you over several decades, a significant portion should be allocated towards capital appreciation and your longer-term financial goals.

To ensure optimal results, it is advisable to consult with your wealth manager who can assist you in identifying favorable opportunities to transfer assets from your long-term allocation to your short-term allocation. These transfers can be carried out in a tax-efficient and sustainable manner, helping you make the most of your investments while minimizing potential tax implications.

2. Focus on diversification

Irrespective of the prevailing market conditions, it is prudent for retirees to maintain a diversified portfolio. By investing in various asset classes, investors can capitalize on the cyclical nature of markets while mitigating overall portfolio risk. This approach ensures that when one sector or investment type underperforms, the presence of another investment type that is performing well helps to stabilize volatility.

Diversification does not guarantee the elimination of losses, but it can reduce the risk associated with being overly concentrated in the worst-performing segment of the market at an unfavorable time. You can achieve diversification by combining different asset classes, such as stocks and bonds, as well as diversifying within each asset class. For example, diversification can be achieved by combining large company stocks with small company stocks, U.S. Stocks with international stocks, and by including stocks from various sectors like technology, financials, energy, healthcare, and others.

3. Follow a disciplined spend-down strategy

To minimize the impact of market fluctuations on your investment portfolio, it is advisable to establish and adhere to a disciplined withdrawal strategy. This entails regularly monitoring and assessing your financial status and objectives. Maintaining open communication with your wealth manager is crucial, as they can collaborate with you to devise a coordinated approach for withdrawals and retirement income that aligns with your lifestyle.

Understanding the tax implications associated with different income sources and withdrawal strategies is essential. Your wealth manager can assist in designing a tax-efficient strategy tailored to your goals.

Considering your unique objectives, tax circumstances, and income requirements, here are two commonly employed withdrawal strategies worth considering:

• Traditional Approach – By employing this method, a sequential withdrawal approach is implemented, where funds are withdrawn from one account at a time. The general order of withdrawal is from taxable accounts first, followed by tax-deferred accounts, and finally, tax-exempt accounts. This sequence enables tax-advantaged accounts to continue growing on a tax-deferred or tax-free basis for an extended period. It is important to note that this strategy may result in varying levels of taxable income from year to year. Therefore, it is crucial to maintain flexibility and consider your present and future tax situation when executing a distribution plan.

• Proportional Approach – Under this withdrawal strategy, a predetermined percentage is set for annual withdrawals from each account, determined by the proportion of retirement savings held in each account type. This approach aims to achieve a more consistent tax burden from one year to another, effectively spreading out your tax liabilities throughout your retirement period. By adhering to this strategy, you can work towards establishing a more stable and predictable tax bill over time.

Regardless of the chosen withdrawal strategy, it is essential to establish a baseline spending objective and regularly reassess it on an annual basis. Unexpected expenses are bound to arise, and the key to success lies in maintaining the self-discipline to identify and address periods of excessive spending. It is crucial not to let a temporary increase in spending negatively impact long-term retirement goals. It is necessary to take the necessary steps to realign with the established plan and remain committed to the broader objective.

The advantage of maintaining a disciplined approach is that it helps ensure the availability of sufficient assets to sustain your retirement lifestyle throughout your lifetime, irrespective of market volatility. By adhering to this disciplined approach, you can enhance the longevity and resilience of your retirement savings.