If you’re nearing retirement, the stock market’s recent plunge probably has you worried about your nest egg.
This descent into a bear market amounts to a financial beat down. And as boxer Mike Tyson once said, “Everybody has a plan until they get punched in the mouth.”
The Dow Jones industrial average losing nearly 30% of its value in a few weeks is analogous to a jab to the jaw. The unsettling volatility, with the market suffering daily swings of 5.34% in March vs. moves of less than 1% last year, according to S&P Dow Jones Indices, led to emotional reactions from many 401(k) investors.
Yet, protecting your retirement account from a knockout blow requires a financial plan to ensure you exit the downturn in as good as shape as possible. Fortunately, retirement isn’t a one-time event but plays out over decades. So, there’s time to recover from market drops.
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To stay on course, it’s best to slice your retirement savings into different buckets, says Nicole Horton of Copeland Horton Wealth Management. Create a bucket of cash for short-term needs, a bucket for growth investments like stocks for long-term wealth building and a bucket for mid-range financial obligations.
Here’s some advice on how to cope with volatility:
If you’re 1 year from retirement
Don’t get too caught up in the scary day-to-day headlines, says Daniel Duca, managing advisor at Altfest Personal Wealth Management. The broad stock market’s 20% drop in the first quarter may spook you into thinking your portfolio is down that much. But it likely held up better if you’re diversified. A $100,000 portfolio at the start of 2020 that was 60% stocks and 40% bonds and cash, would only have suffered a $12,000 stock decline through March 31, not $20,000. Following financial news too closely can “confuse the situation and add to anxiety,” Duca says.
*Establish a cash cushion
The timing of the current sell-off isn’t ideal for workers with plans to retire this year. Falling asset prices deliver an immediate financial and psychological blow. But there are ways to soften the short-term hit to your 401(k).
First, analyze your cash position. You need money that’s not tied to investments that you can quickly access to pay bills and cover expenditures when you stop working. That’s especially true if this bear market lasts 20 months like the average bear since 1929.
Since retirement could last 10, 20 or 30 years, you need a cash cushion to avoid having to raise money by selling assets with future growth potential like stocks that are now worth a lot less. Ideally, you’ll want six, 12 or 18 months of living expenses saved, financial advisers say. You want to avoid having to sell stocks at the wrong time
“It helps emotionally to know that you can weather a market downturn without cashing in your long-term assets,” says Brian Sabo, a retirement and estate planner at Verdence Capital Advisors.
If your cash position is lower, or nonexistent, and you need cash going forward, there are ways to rebuild your emergency fund. Ideally, you’ll want to raise cash by selling holdings that have gone up in value, such as bonds, says Mischelle Copeland of Wells Fargo Advisors in Fort Worth, Texas. If you must sell stock, don’t do it on a day when the Dow falls 1,000 points. Instead, sell into rallies like the nearly 4,000-point, three-day jump the Dow enjoyed the week of March 23rd. “You’re better off selling when the market is up two or three days in a row,” she says.
And don’t yank out all the cash you need at once, adds Duca. “Take it out in stages,” he says. A systematic approach works best. Pick a time frame, such as the first of the month or the end of a quarter, to sell stocks. “It removes some of the emotion from the decision-making,” Duca says.
You might also consider funneling your retirement plan contributions into a cash account within your plan. Or you can stop contributing to your 401(k) altogether and have the extra cash go directly to your paycheck. The downside? You won’t be able to buy stocks at discount prices after big declines.
*Review your asset mix and rebalance
The best time to figure out how much risk you can stomach is when stocks are in freefall, says Sabo. The two things pre-retirees should do now is review their asset mix to see if they own too many stocks to sleep at night, and rebalance their portfolio to get the size of their stock and bond holdings back in line with their initial plan. If you had a 60% stocks/40% bond allocation, and your stock portion has dipped to 50% due to the sell-off, rebalancing forces you to face your fears and sell bonds and buy stocks now to get back to 60-40, Sabo says.
“If you’ve been having serious thoughts about selling off all or a portion of your portfolio, then your allocation to stocks is most likely too high,” Sabo says. “It’s essential to get your investment allocation and risk tolerance dialed in before retirement.”
*Downsize short-term expectations
If you were planning on a big purchase like a retirement home or new furniture, “now might not be the most opportune time,” says Copeland. You might also consider putting off retirement if you can keep working or consider getting a part-time job to supplement your income if you do retire, adds Duca. If you retire at 62, which is the first year you can tap Social Security, “it’s worth considering the benefit of taking a reduced benefit” by applying for Social Security before your full retirement age, Duca says. But since you’ll lose a sizable chunk of your benefit if you take your benefit early, Duca recommends analyzing the pros and cons.
If you’re 3 to 5 years from retirement
The average bear market length since 1929 is 20 months and the time it takes to get back to even after a bear is 24 months since World War II. That means investors three to five years from retirement have a bit more time to ride things out.
But that doesn’t mean these investors should do nothing. Here are steps to take:
*Don’t trash cash
You should always have cash on hand when markets turn rocky. Why sell a fund that invests in all the stocks in the S&P 500 when prices are down. If you have cash to ride out a short-term storm, you can remain invested and not sell near a market bottom.
*How to get back in if you got out
Hatch a plan to get back in the market in a systematic, non-emotional way, says Horton. “Take a disciplined approach,” she says. Make a schedule to layer back into the market. Buy a set dollar amount every month, every quarter or tie the purchase to a specific market level.
If you’ve been regularly contributing to your 401(k) on the way up, it makes even more sense to keep buying when prices are 25% to 30% lower, says Copeland of Wells Fargo Advisors. Dollar-cost averaging means you’ll buy fewer shares of stock when prices are high and more shares when prices are low. “What you want to do is buy when (stocks) are on sale,” Copeland says.
*Remember to rebalance
Keeping your portfolio’s mix of stocks, bonds and cash in-line with your long-range plan is a good way to control risk. Say at the start of the year your plan called for 70% to be invested in stocks and 30% bonds. Well, after a 20% first-quarter decline for the S&P 500, you’ll likely have closer to 60% of your money invested in stocks now. So, take cash or profits from the bond portion of your portfolio and buy stocks now to get your equity allocation back to your initial plan.
“One of the unappreciated beauties of rebalancing is it takes away the most wealth-destroying question out there: ‘Is now a good time to invest?’“ says Bruce Weininger, senior financial advisor at Kovitz Investment Group. “It forces you to buy low and sell high, which is the opposite of what most investors do.”
If you’re 10 years from retirement
If you’re a decade from retirement, dealing with short-term paper losses, while uncomfortable, should cause less anxiety.
The reason: There’s plenty of time to recover your losses and build your wealth with the help of cheap shares you bought in bear markets.
Weininger notes that even if you had bought at the market peaks before the 1987 crash, the dot-com bubble in early 2000 and in 2007 before the Great Recession, you would have recovered all your money and more despite poor market timing.
“Pull up a stock chart going back to the 1920s and look at all the ugly periods,” says Weininger. “Even if you invested at the top if you had a 20-year time horizon, you did OK.”
The bottom line: If you’re 10 years from retirement, keep investing and regularly rebalancing your portfolio. And, most important, try not to get spooked out of the market when prices are falling. Because that’s when you’re getting more shares for each dollar you invest.