In retirement, your focus changes. You’re not putting money into your portfolio anymore. Instead, you’re pulling money out. It’s smart to have a strategy for pulling that money out, especially during major market corrections.
Many people have a withdrawal strategy that ends up hurting them in market downturns. When they retired, they, or their advisor, decided on a withdrawal amount that they could adjust for inflation each year. So they’re coasting along and boom! A Great Recession happens.
From October 2007 to March 2009, the Standard & Poor’s was down over 45%—the worst correction in recent history. We now call that 2007–09 period the Great Recession, but it came close to being a depression.
Many retirees made massive cuts to their spending during the recession. For example, if their portfolio income fell 15–20%, they adopted the strategy of cutting their spending by the same amount.
The strategy sounds logical, yet it’s not necessarily the best one. When you cut your spending 20%, your life gets painful. Here is the retirement you saved for, and those vacations you dreamed of? The games of golf you waited for? Gone—at least until the market recovers and you can increase your spending again.
When the market crashes and your strategy is to simply cut back by the amount your portfolio drops, then your money is going toward essentials only, like groceries and utilities. That makes for a painful way to spend retirement.
There is an alternative income strategy, and that’s to make a small permanent reduction in spending until your portfolio recovers and your financial planning projections improve.
Say that the market drops 20%, and the economy takes three hard years to recover. You can:
If you take the latter strategy, then you can increase your spending again after your portfolio recovers, your projections improve, and the portfolio is back on track. If you have a well-thought-out withdrawal strategy and enough cash (three years of portfolio draws) to make it through a correction, you will typically find you can return to normal spending in three to five years.
In retirement, you’re living off dividends and interest, and sometimes even principal withdrawals. It’s crucial that you keep close tabs on your finances. Understanding your finances will help you know when your portfolio has recovered enough to increase your spending after a period of rough markets.
You should make sure to analyze your finances and investments each quarter. Take the time to compare your spending against your retirement plan projections. Study your tax and health care expenses to determine whether they’re in line with what you anticipated. Take a look at your portfolio and your other income sources to make sure they’re on track with projections as well. If everything looks healthy but your spending isn’t going as far as before, then it may be time to increase your withdrawal rate.
Let’s face it: Market drops will come, and decimating your spending to survive a downturn is a terrible way to spend your golden years. By keeping an eye on your portfolio and having a plan for when markets go bad, you can gain peace of mind that you’ll be OK even when the market is not.