What retirees and older workers can do about stock market volatility

Older workers and retirees might be nervous over what the volatile stock market of late means for their nest eggs. So here’s why now is the time to remain calm.

All that’s happened so far is the market has roughly given back its year-to-date gains during 2018. If you’ve been invested in the stock market for the past several years, you’ve most likely enjoyed very good returns – much better returns than if you’d invested in bonds or other “safe” investments.

Also understand that nobody can reliably predict when the market will crash or recover. The best you can do is to adopt strategies that help you ride out stock market crashes when they happen — without needing to know exactly when they’ll happen.

To that end, here’s a two-step strategy that can protect your retirement from stock market crashes:

1. Develop sources of monthly lifetime retirement income that don’t drop if the stock market crashes. Use these “retirement paychecks” to cover your basic living expenses, or at least come close. Basic living expenses include housing, utilities, food, medical insurance premiums, and income and property taxes.
2. Invest the rest of your savings to generate “retirement bonuses” that have the potential for growth but might drop if the stock market crashes. Use these bonuses to pay for discretionary living expenses, such as travel, hobbies and spoiling your grandchildren. Hopefully you can reduce these expenses when the market crashes.

Sources of “retirement paychecks”

The best source of retirement paychecks is Social Security because it protects against three kinds of risk: stock market, inflation and longevity. It makes a lot of sense to maximize your Social Security benefits with a thoughtful delay strategy.

Another good retirement paycheck is a monthly pension from a defined benefit plan (if you’re so lucky), whether that’s a traditional plan or a cash balance plan. Whatever you do, resist the temptation to take a lump sum payment, if you’re offered that choice. Why? It’s very hard to generate more lifetime retirement income by investing the lump sum, compared to simply electing the monthly pension. If you elect the lump sum and invest it, your money is now vulnerable to stock market crashes.

If you need additional retirement paychecks to cover your basic living expenses, consider using a portion of your retirement savings to purchase a low-cost immediate fixed income annuity that you can buy from an insurance company through a competitive annuity bidding platform, such as Income Solutions. It’s like buying a personal pension.

Sources of “retirement bonuses”

Once you’ve covered your basic living expenses with a portfolio of retirement paychecks, you should feel confident that you can ride out a stock market crash. This can enable you to invest your remaining retirement savings significantly in the stock market, either in a low-cost target date fund, balanced fund, or stock index fund. You can use a systematic withdrawal strategy to calculate your annual retirement bonuses, or you can simply use the IRS required minimum distributionto determine your annual withdrawals.

Another way to generate retirement income from your retirement savings is to use just the interest and dividends to pay for living expenses and keep your principal intact. The volatility in the amount of the investment cashflow is much less than the volatility in the value of the underlying investments. Hopefully this strategy will also enable you to ride out stock market crashes.

A warning for older workers

Are you within a few years of retirement and fully invested in a target date fund? If that’s the case, you may want to take steps to protect yourself if the market crashes before you retire. Your first priority is to prevent needing to start Social Security before the best date for you, due to a layoff or health shock. To meet this goal, consider building a “retirement transition bucket” with a portion of your retirement savings. Invest this bucket in funds that won’t drop if the market crashes, such as money market funds, short-term bond funds, or stable value funds.

Your retirement transition bucket should probably equal a few years’ worth of the Social Security payments that you’ll be delaying. You might also want to add to your retirement transition bucket if you’d feel more comfortable with an extra cushion of money to cover your basic living expenses during the period covering a potential stock market crash and its aftermath.

Once you do that, you can invest your remaining savings significantly in the stock market, confident that you’ll be able to ride out stock market crashes.

For more details on some of the strategies described here, see this recent paper by the Stanford Center on Longevity, prepared in collaboration with the Society of Actuaries.

Don’t worry – be happy! Take steps to protect against the inevitable stock market crashes that will happen during your lifetime. Then go enjoy your retirement.