How to Make Your Nest Egg Last When Retiring Into a Down Market

I think it's safe to say that absolutely no one likes to watch their retirement account balance drop during a stock market decline.

For those on the doorstep of retirement, falling portfolio values can present an even bigger potential threat to your financial security.

And while you may know the data on the?benefits of the decision to buy and hold stocks for the long run, there are points throughout your investment journey where you'll experience markets retreating.

In fact, the market environment that investors experienced last year was referred to as a bear market, which occurs when markets drop more than 20%.

Bears markets are never fun, they’ll test your conviction, but they won’t last forever.

As you’ll see in the chart below, from 1926 through 2021, the S&P 500 Index has experienced 17 Bear Markets. Each decline has ranged in severity and on average has lasted about 10 months.

Statistics on Retiring During a Down Market

Market declines within the first five years of drawing down retirement assets can significantly impact the chance of the portfolio lasting, especially when planning for a retirement horizon that could span decades. Source:?T Rowe Price.

In fact, a?Vanguard study?estimated that if you entered retirement during the peak of a down market with a balanced portfolio (50% stocks & 50% bonds) and relied solely on that portfolio for 100% of your income,?making withdrawals when stocks are down could increase the chance of running out of money by 31%.

You may be thinking to yourself, but I thought I had enough money heading into retirement.

Why is this? Or, how could this occur?

During a down market, when your portfolio balance has declined significantly,?every withdrawal you make turns a negative return,?which is temporary in nature, into a permanent impairment of the balance.

Said another way, the amount withdrawn at a considerable loss reduces the opportunity to recover over the long term,” the Vanguard researchers wrote.

Once that dollar has been taken out and spent in retirement, it loses it's magic of being able to recover and grow through compounding.

So what are you to do?

How are we to navigate poor market returns in retirement and manage portfolio withdrawals to ensure a successful retirement?

Five Strategies You Can Use to Get Ahead of Declining Markets & Improve Your Retirement Outcome

1. Increase Savings Ahead of Time

As a general rule of thumb, I like to recommend having two to three years of living expenses in a money market fund if you are at or near the place of beginning to take monthly withdrawals from your retirement account to live on.

So if you plan on spending $75,000 per year in retirement, then you’ll want to try and reach $150,000 -$225,000 in this bucket.

Why is this important?

This bucket of money is where you would first draw from during a down market, so you don’t have to sell your stocks at a loss.

The idea behind this strategy is that you’ll have access to cash in the short term, so you won’t have to worry about fluctuations in the stock market.

Thus, as the stock market continues to grow and/or recover, your war-chest is refilled by interest income, dividends, and the performance of your more risky and long-term investments.

2. Be Flexible With Your Spending Strategy

Dynamic Spending is an adaptive spending approach that can help you weather the worst recessionary markets by?spending less temporarily?until calmer markets prevail.

Simply put, dynamic spending allows you to you increase your portfolio distributions when your investments do very well, but when your portfolio value drops a lot, you cut your spending.

It's only when retirees continue to spend the exact same amount or more during market downturns is when trouble begins to occur.

Instead, by following a flexible spending approach throughout retirement and knowing that there may be times when temporary adjustments are needed, you'll be able to weather the markets with greater certainty and portfolio longevity.

Vanguard Research?writes, "By countering a decline in portfolio value with an incremental decrease in planned withdrawal amounts, even those bearing the worst sequence of return risk could have eliminated the possibility of premature portfolio depletion."

3. Focus On What You Can Control

Market returns are random, but the decision to work an extra year or take a part-time job is entirely within your control.

The difference between those who retired into the worst years of a bear market compared to those whose retirement date was shifted by a year or two resulted in staggering retirement portfolio outcomes.

Why is this?

Going back to what we covered at the beginning of this article, during a down market, when your portfolio balance has declined significantly, every withdrawal you make turns a negative return, which is temporary in nature, into a permanent impairment of the balance.

Thus, by delaying your retirement a year or two during a down market, you're not taking distributions from your portfolio and instead, are still working, adding dollars into your portfolio, and are allowing your investments the ability to recover and grow through compounding.

4. Alternative Sources of Income are Crucial

The name of the game in retirement is portfolio longevity.

Earlier, we mentioned the importance of having a well-funded war-chest of cash to be able to cover 2-3 years' worth of living expenses, so that you won't be forced to sell stocks during a market downturn.

In addition to having a well-funded emergency savings, having other sources of income in retirement to draw from can help keep your portfolio alive and growing. Some examples include:

• Delaying Social Security to receive a larger lifetime benefit
• Working just a bit longer
• Finding a part-time job that you love to bring in extra income
• Downsizing your house

5. Proper Asset Allocation

Have you ever experienced turbulence on an airplane before?

What's the phrase the flight attendant says upon going to retrieve your items from above?

"Please use caution when opening overhead bins as items may have shifted during the flight."

The same principle applies to your investment portfolio and the overall mix of stocks and bonds ... we call this asset allocation.

During times of market volatility, it's important to periodically review your portfolio and rebalance it back to its baseline as needed, to ensure that it still aligns with your financial objectives and risk tolerance.

Getting back to baseline could mean buying or selling a percentage of your assets to maintain your desired allocation of stocks, bonds, and cash.

It's important to not make the mistake of becoming too conservative during a down market and putting all your assets in cash or bonds.

Even in retirement, most investors will still require some exposure to stocks to outpace inflation and preserve purchasing power.

Conversely, during times of market booms, as we experienced from 2010-2021, it is equally important to rebalance our portfolios so that they do not become too top-heavy with stocks.

Getting caught being too aggressive in a market downturn just before retirement could result in experiencing higher-than-expected losses and jeopardize your retirement.

Final Thoughts

We know that market returns are entirely random and it is pure luck to whether you will experience a positive sequence of market returns (the order in which markets rise and fall) during your retirement or a negative one.

That said, though you may not be able to control the markets, you can control when you decide to retire and how much you decide to spend.

By following a flexible withdrawal approach in retirement and planning for temporary adjustments along the way (if needed), you can ensure you're doing everything within your power to weather the markets and have a truly fulfilling and enjoyable next phase of life.