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If you’re nearing retirement, be sure you’re managing this big risk

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You may want to consider a portfolio re-evaluation if the volatility in stock markets is troubling you as you get closer to retirement.

As a retiree, one of your biggest concerns is the possibility that there will be a persistent downturn in the market. Just as you are starting to tap into your savings, this could also pose a risk. Research has shown the damage this can do to your portfolio over time (more details below). It’s worth investing in retirement so that you have money that minimizes these risks.

“One of the things that I’ve seen too much of … is retirees being invested way too aggressively early in retirement,” said certified financial planner Carolyn McClanahan, founder of Life Planning Partners in Jacksonville, Florida.

Get more advice from the advisor:

The Russia-Ukraine war causing uncertainty in an already-sliding market has caused major indexes to continue zigzagging through the pullback. The year to date has seen the following: S&P 500 Index — a broad measure of how U.S. companies are faring — is down 8.8% though Monday’s close. This is the Dow Jones Industrial AverageThe composite Nasdaq index, which is tech-focused, has fallen 13% so far this fiscal year.

The math looks better over the longer-term, however: The S&P is up more than 12% over the last 12 months, the Dow is up nearly 7.5%, and the Nasdaq’s one-year return is about 1.2%. It’s difficult to forecast where the market will move from now, but volatility can be expected.

For long-term savers — those whose retirement is many years or decades away — the ups and downs of the stock market generally matter less because their portfolios have time to recover before being relied on for cash flow.

Retirement is an entirely different matter. For those who are just starting that new chapter in life, it can become a very serious problem.

A “sequence risk” can have a lasting negative effect on your portfolio, according to research. When liquidating investments, this risk is about the sequence (or order) of your returns over time.

This chart shows the differences between market losses and market gains at retirement. Both portfolios have the same investments, experience identical annual returns and are shown in the following chart. However, the orders of 25-year periods show that they were held in different order.

Each hypothetical portfolio starts with $100,000, and experiences $5,000 per year withdrawals. Portfolio A has negative returns while Portfolio B suffers losses over the course of 25 years. This is the stark difference: Portfolio A’s assets are depleted in 20 years, and Portfolio B will have more than twice as many assets.

“It is crucial that today’s pre-retirees and retirees understand the importance of this concept.” [that risk]Vance Barse (wealth strategist, founder and CEO of Your Dedicated Fiduciary with offices in San Diego, Prosper and Texas) said, “To their nest egg.”

It’s worth looking at your portfolio to ensure that it addresses the sequencing risk if you are nearing your retirement date. This means that you should keep the money needed to pay your bills away from stocks or other more risky investments.

Advisors suggest that you have one to two years worth of cash or cash equivalents in order to prevent selling into the down market. 

Make sure that you’re able to pay your bills in order not to have the need for a sale. [investments]To have cash,” stated David Peterson of Fidelity Investments’ wealth planning department. It’s not a good idea to invest in the down market.

A good understanding of your sources of income, such as Social Security, pensions, and annuities, is a key part in knowing the amount of cash that you really need.

Barse stated that many people accidentally reduce their spending.

You should ensure that your cash is not too invested in stocks.

McClanahan of Life Planning said that her clients who are retired have five years worth of conservative investments in order to provide cash flow.

McClanahan explained that McClanahan suggested this because they do not need to wait for a market crash to solve the problem.

She said that for new retirees whose savings is just enough — i.e., there’s not a lot of room for error — a conservative portfolio comprised of 50% stocks and 50% bonds may be appropriate.

McClanahan stated, “But we do have clients who are only 30% to 40% in stock,” It’s all about the risk that you are willing to take psychologically and financially.

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