If Retirement Is Near, Avoid Drastic Moves
For people nearing retirement the current market volatility has been a wake up call, provoking many to reevaluate whether their investment portfolio will be able to support them throughout their lifetime.
While a portfolio check-up is a good thing, experts warn not to make any knee-jerk moves based on current events. Instead, they emphasize investors should use the occasion to ensure they have an asset allocation in place that fits their risk tolerance and will provide enough income to last through retirement.
“What happens in market extremes is that people tend to get very emotional,” said Gayle Buff, president of Buff Capital Management, adding the trick is, “use the panic mode wisely.”
“Some people could be holding really bad portfolios for themselves while for others the value of their portfolio has not been impacted,” she says. That’s why, “you don’t want to just react to an extreme market situation, but if you are using that as a backdrop to reassess where you are, that is a good thing.”
Joe Appolito, a certified financial planner with Associated Securities, says investors often get nervous during volatile markets and decide to pull money out of stocks and put it into lower risk investments such as money market funds or cash.
For some people shifting funds into different investors may make sense, but it has to be done in a calculated way -- to maintain the long-term goals of the portfolio, not because of the market behavior.
The problem with making market-based moves, Appolito says, is that, “no one knows when the bottom is and no one knows where the top is of the market cycle.” As a result, people make the wrong moves at he wrong times.
What's Inside -- What To Do
So if retirement is just around the corner but these ups and downs have you second guessing your portfolio, how do you know if its time to make some changes?
According to Stewart Welch III, founder of wealth management firm, The Welch Group, the first step is to determine how your assets are currently allocated. Knowing what’s inside will help determine what, if any, changes need to be made.
The next step is finding out what your proper asset allocation is. When determining this, Welch says you should start by deciding broadly how the assets should be distributed between fixed income -- which includes money markets, CDs, and bonds -- and equities, which are typically stocks, mutual funds, ETFs and REITs.
As a minimum, Welch recommends clients have a 50% to 60% allocation for stocks, though, he says the exact number will depend on factors including how many more years of cash flow the client needs.
Because of market behavior, some people, specifically those who are risk averse or who have a short-time before they retire, have been cashing out of stocks and into bonds, as they are often considered safer and less volatile investments. However, Welch says the problem is, “if you move too much to fixed income you might not have enough money to last through retirement.”
That’s why another factor in determining your asset allocation is knowing how much you plan to withdraw once you are in retirement. This is essential to make sure you will have enough money to last as long as you need it to.
A 4% to 6% withdrawal rate per year is typical, Welch sys, adding that for a rate above 4% it is wise to have at least 50% in equities in order to make sure you will continue to generate enough income as your portfolio shrinks. “The key is to set up a program that doesn’t force you to sell equities in a bad market,” he says.
But that’s not as simple as it seems.
According to Appolito, “Most people are looking for assurance that their income will last as long as they live.” Alas, it often it doesn’t work out that way.
For instance, say you are drawing 5% to 6% of your original portfolio annually. At that withdrawal rate you would be fine as long as your portfolio continued to increase at a rate above that. But when the market goes down, and the value of your portfolio also falls, even if you continue to withdraw the same dollar amount, you are draining 7% or 8% of the portfolio’s value. In addition, Appolito says, to build the value of the portfolio back up while you’re still withdrawing is very difficult.
Because creating a successful asset allocation can be tricky, it is a good idea for less sophisticated investors to enlist a qualified financial planner who can do an in-depth analysis that will help determine a proper asset allocation based on your risk profile and retirement plans.
But whether you plan to do it yourself or go through a financial advisor, the bottom line is, while major market moves can be jostling, sticking to a solid long-term asset allocation plan is the best way to ensure your money will last.