As I write this, many retirees are having their retirement savings devastated by the current market correction. The unfortunate thing is much of this could have been avoided with proper planning and an appropriate distribution strategy.
Unfortunately, many retirees are still using accumulation strategies to manage their investments during retirement. Let me explain. A prudent investment strategy for a 25 year old is to dollar cost average into their investments with every paycheck. Individuals that participate in a 401(k) are a good example. When the stock market drops, they are actually buying more shares for the same dollars invested. Over time dollar cost averaging allows them to purchase more shares at a lower average cost per share.
However, once a retiree begins to take systematic withdrawals from investments in retirement, this strategy is not valid. It becomes negative dollar cost averaging. When the market drops, the retiree is selling more shares to generate the same monthly cash distribution for living expenses. Accordingly, when the stock market recovers there are fewer shares to participate in the recovery. It can devastate a portfolio!
You need to use a different strategy in retirement. As a general rule, I would recommend a retiree keep about one year of living expenses in cash. Should you have an unexpected emergency, this will create an adequate emergency fund so you don't have to raid long-term distribution vehicles or equities.
Next, you should shift a portion of your investments to income distribution vehicles for monthly living expenses. The goal is to supplement social security and any pensions with investments that can produce an income stream. Some examples are non-traded REITs, annuities, and bonds. These investments are insulated from the volatility of the equity market and are designed to generate income.
Lastly, a portion of your investments should remain in the stock market. However, you should not plan on taking distributions from these investments on a systematic basis. Every five to ten years, you will need to harvest some of the gains from your stock portfolio and convert these funds to income distribution vehicles like those mentioned above. This is necessary because inflation erodes purchasing power over time. You should also make this conversion at the height of a bull market, if possible. The worst time to harvest these investments would be in a bear market.
Failure to shift strategies from accumulation to distribution can jeopardize your ability to remain financially independent in retirement.
John E. Richardson, Jr., CPA, CFP® is a Senior Financial Advisor with Strongtower Financial in Escondido. If you have any questions or comments, please contact him at (760) 705-3520 or by e-mail at: