What Should You Do If You Retire In A Bear Market?

The stock market has taken investors on a wild ride over the past several months. It is during these volatile times that I experience a higher volume of calls from individuals who are concerned about their retirement assets and wondering what they should do. My most concerned callers are those who are getting ready to retire. With memories from the 2008 financial crisis and the volatile pandemic dip of 2020 still fresh in their minds and now inflation running rampant, many are asking, “What should I do if I retire in a bear market?” Here are three different strategies to consider that may allow you to still retire when you want to without the market fluctuations (or downturn) affecting your plans or causing you to run out of money sooner than you originally thought:

Strategy #1: The Bucket Strategy

How it works: To use some jargon, this is also called the time-based segmentation approach. With this strategy, you think of your money in 3 hypothetical buckets that are aligned with your spending needs and the timeline for those needs. For example:

Bucket 1 (short-term): This is the money that you anticipate needing to withdraw over the next 3 to 5 years. Most people will put this bucket in cash or in very conservative investments. The idea is that this money is protected from market downturns while the rest of your investments can have time to recover (aka grow back with the market) before you need to begin withdrawing them.

Bucket 2 (medium-term): This bucket is the money that you may need within a 5 to 10-year period. Most people would invest this bucket in medium and longer-term fixed income assets such as bonds or bond funds.

Bucket 3 (long-term): This is basically the rest of your money, which you estimate you won’t need to withdraw for 10 or more years and therefore what you want to keep growing. You’ll typically use stocks (aka equities) for this bucket as you’ll have time for this money to recover from any longer-term bear markets and ideally will continue to grow over the years.

The drawbacks: It can often be difficult to trust the process and not let emotions get in the way. During up markets, you may feel like the cash you set aside is just not working hard enough and that you should take on more risk. Likewise, during down markets, you might start feeling anxious and that you should move your money into cash for safety. Both reactions can hurt you as it is nearly impossible to time markets consistently over the long run.

What to be aware of: It can be challenging to manage money you have across different account types like tax-free (Roth), taxable (brokerage accounts), and tax -deferred accounts (IRA/401k). Ideally, you may want to align your investments in the right type of account to derive the greatest tax benefit. (For example, higher growth investments/high income investments may go in a Roth account so that you can earn tax-free growth and not worry about capital gains/income tax, while municipal bonds earning tax-free interest make more sense in a taxable account.)

What can make it work better: Sticking to your plan and having a strategy in place to replenish and reallocate your buckets while being mindful of the type of accounts your assets are invested in is the key to success with this strategy.

Consider funding your short-term bucket by using the more conservative short to medium term bonds in your medium-term bucket as they are typically the assets that will be most stable. To replenish your medium-term bucket, you can take the gains from the assets that have grown in your long-term bucket and reallocate them. Ideally, you are following an appropriate asset allocation strategy based on your goals, time horizon and cash needs so this should flow into your investment process.

Strategy #2: Essential vs. Discretionary

How it works: With this approach, the goal is to take retirement savings that you need to fund essential expenses (such as housing, health care and daily living expenses) and invest them into assets that produce guaranteed income such as annuities. The remaining savings would only be used for discretionary expenses (like travel, non-essential home improvements, etc.) and would remain invested in more growth-oriented vehicles such as stocks.

The drawbacks: The drawback to this method is that some discretionary expenses might actually be considered essential to an individual with a minimum retirement lifestyle in mind. If for some reason their discretionary assets did not last, then those individuals might have preferred to continue working until that lifestyle could have been accomplished versus living more frugally in retirement.

What can make it work better: Consider dividing your savings into 3 buckets but with different labels: the essentials, the discretionary non-negotiables (traveling to visit friends and family), and the truly discretionary (like taking your whole family on a globe-trotting vacation when times are good versus just hosting the grandkids at your home when the market is down). Individuals looking to secure a minimum retirement lifestyle could place the expenses that are essential and non-negotiable into guaranteed income buckets. The remaining assets would then be set aside for the truly discretionary items that they could live without or wait for if necessary.

Strategy #3: Fixed Rate Withdrawals

How it works: This strategy is otherwise known as (jargon alert) systematic withdrawals. It is the process of taking money out of your retirement accounts based on regularly scheduled fixed (percentage or dollar) amounts. For example, a popular systematic withdrawal method is the 4% rule. The idea behind this rule is that you can “safely withdraw” 4% of your initial savings and increase that amount each year with inflation without a significant probability of running out of money.

The drawbacks: The drawbacks include the risk of a large market downturn early in retirement or not accounting for the various income needs, lifestyle, and family dynamics of individuals. For example, if you needed $5,000 a month and your fixed income (Social Security, pension, annuities) gets you to $4,000 a month, you need that extra $1,000 (whether its 4,5, or 10% of your savings) no matter what happens. In other words, one size doesn’t fit all, which means there is no guarantee that the 4% rule in and of itself is the best approach for you.

What can make it work better: This approach can work in the above considerations as long as you also build in some rules around how you will change your retirement withdrawals according to what the market/your investment savings are doing. For example, perhaps you would reduce your withdrawal percentage during down markets, and/or possibly tap into stable and liquid assets (such as a cash savings account) to help meet your needs while giving the investments that have taken a beating some time to recover. For example, a colleague of mine shares that he plans to keep 3 years of expenses in cash and when market downturns occur, he might reduce his withdrawal to 3% and supplement his needs from his cash reserves until his other assets recover.

How to decide which is right for you?

Since there really isn’t a one size fits all approach, setting up these rules will require thought, foresight, and planning. All of these strategies require you to have an idea of what your annual financial needs will be. Consider consulting with a qualified and unbiased financial planner to help you determine how much income you’ll need and what the best retirement withdrawal approach is for you. They can also help you maintain and update your strategy as you go along. Don’t be too fearful about recessions and bear markets because with proper planning and preparation, you can develop a withdrawal strategy that can outlast the worst of them while helping to ensure that your savings can last as long as you live and beyond!