We’ve all heard the age-old advice about having an emergency fund while we are working, perhaps 3-6 months’ worth of expenses in case the unexpected happens. Whether “unexpected” means job loss, sickness, or just unplanned major repairs on a home or car, having that safety net in place can reduce financial stress immensely, and protect us from incurring more financial damage in the form of credit card debt or early retirement plan withdrawals.
But what about when we retire, and begin living off of the income that we receive from social security, pensions, and our investment accounts? What happens if the market crashes right when we are ready to begin taking distributions, and our portfolio becomes too sick or too hurt to work? People in the financial industry refer to this as “sequence of returns risk,” or more simply, having bad luck and retiring at the wrong time. We used to hear that a 5% distribution rate would be sustainable, adjusted for inflation, for lifetime portfolio income. As interest rates plummeted during the global financial crisis of 2008-2009 (and even more notably in 2020) that “5% rule” turned into the “4% rule.” But with long-term capital market assumptions from major institutions generally calling for lower returns for both stocks and bonds moving forward, even that 4% figure may not work for everyone, particularly if a portfolio is more conservatively postured with heavy exposure to bonds or fixed income.
So, what can we do? We see more and more research that calls for a dynamic spending approach in retirement, which means adjusting income down a bit when portfolio returns are weaker, to avoid selling too much in a down year. But that can be hard to do! Though we do have variable expenses, many of our costs are fixed and not easy to adjust on the fly. From a practical perspective, it may be best to consider building up an “emergency fund” for our retirement accounts, a fund that we can dip into to take the pressure off of our larger investment portfolio during times of volatility, allowing us to stay invested for the long term.
The COVID-19 pandemic triggered the fastest bear market (20% decline) in history, followed by the fastest bull market in history, so though it was a bumpy ride, portfolios left untouched were largely back to “whole” just several months later. But generally speaking, an emergency fund of 2-3 years’ worth of expected withdrawals (the gap between our income needs and what we receive from social security, etc.) would be a great place to start to navigate a more prolonged downturn. From a pure mathematical perspective, halting systematic withdrawals from our long-term investment portfolio, while values are down, provides obvious benefits (buy low, sell high, right?). But just an importantly, having that safety net in place and knowing that we can live for a few years without even touching our remaining nest egg prevents us from making emotional financial decisions that can hurt us over the long run.
How do you implement this strategy? Many retirement plans offer a stable value or a guaranteed interest account that can be used to safely park a portion of our assets. But it’s just as easy to stockpile these funds in an outside emergency savings account, just like we always have during our working years. Whatever method you choose, just make sure you have a plan in place well in advance of when you are ready to embark on your retirement. And as always, our advisors stand at the ready to help you tackle this question and the variables that make each person’s situation unique.
Securities offered through Private Client Services, Member FINRA/SIPC. Advisory services offered through Prime Capital Investment Advisors, LLC. (“PCIA”), a Registered Investment Adviser. PCIA: 6201 College Blvd., 7th Floor, Overland Park, KS 66211. PCIA doing business as Qualified Plan Advisors (“QPA”) and Prime Capital Wealth Management (“PCWM”). PCIA and Private Client Services are not affiliated.