For many people, making the transition from their working years to living on a fixed income in retirement is scary enough, without having to be concerned about the impact of a sudden market downturn on their nest egg. Falling stock prices can be frightening, but proper planning can cushion your retirement portfolio against market shocks and provide you with the confidence you need to stick with your plan.
The planning triad of cash flow management, investment strategy, and income distribution is the key to fortifying your retirement plan in your pursuit of lifetime income sufficiency.
Cash flow management
You spend your working years socking away money into your retirement plans to accumulate the capital you’ll need to cover your lifestyle needs in retirement. You know what you’re spending now in pre-retirement, but do you know precisely what you’ll be spending in retirement? Having a firm grasp of your spending needs in retirement is the key to positioning your retirement portfolio to generate enough cash flow in any market environment.
People are living longer today, and longevity risk (the risk of outliving your income) is compounded by inflation. Cash flow planning should be based on the realities of aging today. To get a firm grasp of what your cash flow needs will be in retirement, start tracking your expenses today. Which will remain in retirement? Which will go down? Which will increase?
Going into retirement with a concrete number for what you will need will help you make better cash flow decisions and inform your overall investment strategy.
There was a time when bonds were the go-to investment for retirees. They were reliable and safe and had sufficient yields to generate their needed income. The problem is that bonds were never designed to combat inflation. With today’s inflation-adjusted yields on bonds turning negative, they can’t produce the income needed, and they can be a drag on portfolio performance. In a rising interest rate environment, bonds are guaranteed to lose value.
While bonds can still play a key role in diversifying a retirement portfolio, retirees should change their mindset from that of depending on bond yields, to relying on total returns. Total returns are generated from both capital appreciation and yields, specifically from dividend-paying stocks. Some of the best companies have a long history of reliably paying and increasing their dividends, many with yields higher than bonds.
Retirees who expect to live through several market cycles (the average market cycle being five years) can benefit from the growth proponent of their portfolio while cushioning their portfolio with safer investments. For example, the growth component can consist of large, dividend-paying blue-chip stocks that, given five or more years to grow, will provide the inflation hedge needed to protect your purchasing power in later years.
You can create a near-term bucket of cash and ultra-safe securities to be the source of cash flow for three to five years, replenishing the bucket with gains from your stock bucket as they occur. With enough cash to sustain your living needs, it lessens concerns about temporary market downturns.
The income distribution phase of retirement planning is often given short shrift compared to all the planning that goes into accumulating retirement capital. Yet, the income distribution phase can be more complex and more critical to meeting your objective of lifetime income sufficiency. How you distribute your income can determine how well your assets can be preserved. If you have multiple sources of income, including retirement plans, taxable accounts and annuities, you will need to determine the timing of drawing on each to create as much tax efficiency as possible.
How you distribute your income will also determine how to best position your portfolio to generate the returns needed to sustain your nest egg while meeting your cash flow needs. Planning your income distribution across your different accounts can provide more flexibility while minimizing your taxes, injecting your portfolio with more longevity.
The key to preparing for market downturns is to focus primarily on what you can control. You can’t control the market, but you can control your objectives and the decisions you make. People become their own worst enemy when they make emotionally charged decisions.
You’ll be better prepared for market downturns when those worst-case scenarios are built into your retirement plan. A financial advisor can help you plan with projections based on conservative assumptions to ensure you don’t undershoot your objectives. More importantly, your advisor will help you avoid the behavioral traps that doom retirees and help instill the confidence you will need to keep you focused on your strategy.