I think the biggest retirees’ concern regarding their portfolio is probably the fear of losing money. During all those years, you have worked very hard and saved every penny you could. Then, you turned around and invested this hard-earned money in the hope of building a comfy nest egg for the day you will finally stop working. You finally hit your magical number and say “goodbye” to your boss for the very last time. Your coworkers throw a retirement party, you have a few renovations planned on your house and your airplane tickets are already bought for the destination you dreamed about for many years.
After a few months having fun and enjoying life, you open your portfolio statement; there is a number between parentheses. Panic. You go white. For the first time in your life; you lose money while you have no ways to generate more. You depend on your nest egg and you realize it is not as solid as you thought it was. In fact, you realize your retirement portfolio could melt. What can you do?
This is the final article of a 3 parts series on factors hurting your portfolio at retirement. This article is all about how withdrawing money at the wrong timing could affect the rest of your retirement. You can read about the other 2 factors crucial to your retirement with part I here and part II here.
When do you withdraw your money?
In an ideal world, you have saved millions and you only live off your dividends. But this only happens if you managed to saved over 1M$ and all your holdings meet 3 criterions. For others, chances are your retirement income will be a combination of dividend payments and shares sold. If it’s your case, the last thing you want to do is a big withdrawal right in the middle of a market crash.
During my financial planning years, we used to make lots of simulations. One that particularly struck my mind was the difference between an investor retiring right before a bear market vs one that would retire at the bottom of the bear market. The impact of withdrawing money at the same time your portfolio is free falling is catastrophic on your retirement plan. Just imagine if you had retired in July 2008…
I bet that looking at this graph gives you chills considering we have been running a bull market for 10 years and we all know that one day (probably sooner than later), we will get hit by another bear market.
Don’t be desperate just yet; I have good news! If you look closely on the graph above, you will notice that the stock market recuperated most of its’ lost money by January 1st. Statistically speaking, most bear markets will last about 18 to 24 months. Therefore, if you get enough money on the side (e.g. in cash or close to cash), you will not have to sell shares at a loss.
The year before I retire, I intend to make sure I have the equivalent of a full year budget in cash. For example, if I need 50K per year and my portfolio generates 30K in dividend per year, I will cash sell for 50K of shares before day 1 of my retirement. Then, if the market drops, I have a full year where I can withdraw money from my “cash account” without being worried by the market.
During that year, I still have an extra 30K deposited in that cash account. Therefore, at the beginning of year 2 of my retirement, my “cash account” will still show 30K (dividend paid by my portfolio during the first year). If the market hasn’t recuperated yet, I still can use my cash account for another 6 months without being worried. And guess what’s the best part? After 6 months, I will have spent 25K (remember, my yearly budget is 50K/year). Then, my cash account would show a remaining 5K (30K in dividend – 25k withdrawn). I would also add an extra 15K to this amount since my portfolio kept paying the same 30K in dividend. Therefore, I would have enough money to wait until the end of year 2 before I need to share my first share.
As most bear markets don’t last over 24 months, I’m 90% sure of not selling shares at a loss due to a bear market using this method!
Honestly, if you are retired or about to retire, I think you should make an investment of $1,000 to $2,000 outside your portfolio. These two grands may very well be the most important investment of your life. Here’s what you should do: find a fee-based financial planner and pay him to write down a full retirement plan.
He will not only take care of those three factors, but he will also be able to integrate tax optimization in your asset allocation! While you can’t control the stock market and guess how much return you will make next year, you can certainly control how much you will pay on taxes in regards to your withdrawals!