“What happens when I retire, and the market dives like it’s doing now?”

I’ve received this question a bunch this year, and rightfully so. Any prudent person would want to make sure there’s a plan in place to handle bumpy markets while you’re withdrawing money from your portfolio.

Thankfully, you’re not alone, and this isn’t a new problem. It’s something we have taken seriously for years since many of the families we serve are current retirees and rely on the solution to sustain their lifestyle.

We take a four-step approach to address this problem:

Step 1: Diversify Your Portfolio
Duh. Everyone knows not to put all your eggs in one basket. Nick Murray, a well-respected financial author, says “Diversification is the conscious choice not to make a killing, in return for the blessing of never getting killed.” This is such a fundamental part of our portfolios that I display this saying on the bookshelf in my office.

Unfortunately, diversified doesn’t mean bulletproof. There are markets where assets that typically behave differently decide to move in lockstep, which reduces the benefits of diversification. 2022 has been a great example of this. We have seen bonds sell off significantly in response the Fed raising rates at the same time we’ve seen stocks sell off significantly because of recession fears. Bonds typically act as a ballast for portfolios during times of elevated volatility in stocks, but that hasn’t been the case this year.

So, what else can we do to protect your portfolio during retirement? I’m so glad you asked…

Step 2: Bring on the Buckets!
You never want to sell stocks in a down market to buy groceries, and our bucket strategy is how we avoid doing this. We divide retirement portfolios into three buckets.

  • Short-Term Bucket – this is where we get the money we send our retirees each month for them to live. This bucket is full of very conservative investments that provide predicable income and don’t fluctuate much with the market. Let’s say we’re “bunting” with the investments in this bucket. We like to keep between one- and two-years’ worth of withdrawals in the Short-Term Bucket.
  • Intermediate-Term Bucket – this bucket holds investments that carry a little more risk and get a little more growth than the Short-Term Bucket, but still don’t rise and fall as much as the general market. We’re swinging for singles and doubles here. Ideally, we’ll keep between three- and seven-years’ worth of withdrawals in this bucket.
  • Long-Term Bucket – this bucket holds the most aggressive investments. We fully expect this bucket to rise and fall along with the general market. This bucket is the most volatile, but it’s essential to our portfolios because it provides our long-term growth. We’re swinging for triples (and an occasional homerun) in this bucket.

Utilizing these buckets enables us to make sure we’re providing sustainable withdrawals for our retirees because we’re able to pick and choose how to replenish the Short-Term Bucket depending on what type of market we’re in. In a strong bull market, we’ll sell some of the Long-Term Bucket and harvest those gains when it’s time to replenish the Short-Term Bucket.

If we’re in a bear market like we’ve seen this year, we let the Short-Term Bucket get utilized more, and replenish it from the Intermediate-Term Bucket if necessary. This allows us to let the Long-Term Bucket cook a little longer and gives it time to bounce back when the market rallies. Selling stocks in down markets to buy groceries? Not here.

Step 3: Find Good ‘Tenants’
Think of a rental home. One of the main reasons you buy a rental property is because it provides predicable, consistent income. The price of the home rises and falls with the real estate market, but the rental income shouldn’t change unless your tenant loses her job and can’t afford rent.

We take an investment portfolio and make it behave almost exactly like a rental home. We find fantastic tenants that pay steady monthly or quarterly income (in the form of interest and dividends). Just as your rental income doesn’t change as long as you don’t sell the home, your portfolio income doesn’t change as long as you don’t sell the shares. The price of the shares rises and falls with the market, but the income we receive has nothing to do with the price – only the number of shares that we own!

Often our retirees have enough in their portfolio that we’re able to meet their withdrawal needs with the income that we produce by finding good tenants. This allows us to truly leave the principal intact and simply live off the dividends and interest. Talk about peace of mind!

Step 4: Keep an Eye on Your Withdrawal Rate
Even with the above steps, there could be a time where the market has fallen significantly enough where a change might be necessary. How do you know when this is the case? It helps by looking at what percentage of your portfolio you’re withdrawing on an annual basis. A safe withdrawal rate is unique to your individual situation, but a general rule of thumb is that a 4% withdrawal rate is sustainable over a 30-year retirement after accounting for inflation.

Let’s look at an example. Say you have a $1 million portfolio and you’re withdrawing $40k per year. $40k ÷ $1M = 4%, so you’re good to go. Now let’s say the portfolio drops 10%, meaning your $1 million portfolio is now $900k. Your new withdrawal rate is $40k ÷ $900k = 4.4%. Chances are this new, higher withdrawal rate is still ok, but things are getting tighter.

What if the portfolio drops 20%? Now your $1 million portfolio is $800k, and your new withdrawal rate is 5% ($40k/$800k). Do you need to change how much you’re pulling out? Unfortunately, there is no cut-and-dry answer for this one. This is a conversation that needs to be had between you and your advisor to look at your specific situation and make a plan moving forward.

Bottom Line
If you’re already retired or quickly approaching retirement, markets like we’ve seen in 2022 are a legitimate cause for concern. Thankfully, this problem isn’t new, and we’ve been able to develop strategies to help mitigate the risks. Our hope is that you, our clients, know that you’re not alone. We’re always here to listen, talk, and strategize. Hopefully doing so will bring you a little more peace, even in the midst of crazy markets like we’re seeing today.

These are the opinions of Legacy Wealth Management, LLC and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice.

Daniel Funderburk is a Registered Representative offering securities through Cambridge Investment Research, Inc., a Broker/Dealer, bridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Legacy Wealth Management, LLC and Cambridge are not affiliated. Cambridge Advisor. Legacy Wealth Management, LLC and Cambridge are not affiliated. Cambridge does not offer tax advice.

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