Build a retirement portfolio that reduces volatility risk and enhances opportunity. Here’s how.
There are three near-certainties in the investing world: Markets go up, markets go down, and over time, markets have gone up. Sounds simple, doesn’t it? The challenge comes with timing. Can you stomach the ups and downs? What happens if a lengthy down stretch hits at an inopportune time?
Most retirement portfolios are structured to withstand the ebbs and flows, and even deep dives, in the markets. Still, if you’re in retirement or near it, the volatility could put you in a constant state of panic or make you realize real quick that your risk tolerance is much less merciful than you once thought.
If that’s the case, stay calm. “It’s always important to invest with a rational perspective, not an emotional one,” says Matt Sadowsky, director of retirement and annuities for TD Ameritrade. “Responding to a market correction with an emotional reaction is a bad way to handle your portfolio. Don’t sell everything because of fear.”
Your “rational” approach might look like this:
Nobody likes to lose money on a position or take a realized loss, but know the difference, Sadowsky says. An unrealized loss—or the loss you see on your monthly statements—is not the real McCoy. An unrealized loss is the disparity between what you bought the stock for and what it’s trading at. A realized loss is the actual dollars-and-cents dent from subtracting the sale price from the purchase price. If you can sit tight, that gap could narrow.
“But if you’re still worked up by the gyrations of the stock market, then you should reassess if the portfolio is properly balanced relative to the amount of risk you want to take,” Sadowsky says.
That might mean taking a more conservative approach—examples might include an 80-20 or 70-30 mix of bonds and stocks—which may need to be rebalanced if market conditions change. Or it could involve moving toward more defensive sectors like health care and utilities. It might also entail a higher proportion of bonds with higher credit ratings that, because of their perceived lower risk of default, typically carry lower interest rates.
Keep in mind that rebalancing could generate capital gains or losses that might have tax implications that challenge your retirement-funding needs. Consult with your tax professional before you act.
With market muddle may come opportunity. Some investors look with fresh eyes to favorite stocks that are falling because the markets are responding to outside forces like the economic stress from China this summer or currency fluctuations abroad. Retirement professionals say not to change your risk tolerance by putting your retirement funds in jeopardy, but if you can afford to and want to take on more stock, you might do so judiciously.
You might also want to use a down period to convert traditional Individual Retirement Accounts (IRAs) to Roth IRAs. “When you have your assets in a traditional IRA that has been significantly reduced by the market downturn, that might be a time to consider converting into a Roth IRA , where you’re paying taxes on the lower amount that’s being converted,” Sadowsky says. “You have to consider if you want to pay those taxes now or later. I would rather pay taxes when I have a lower tax rate and a lower asset value. Keep in mind that converting a Traditional IRA to a Roth is not for everyone. Again, here's a reminder to consult with your tax advisor before converting."
“The 4% rule is a rule of thumb, not a law,” Sadowsky says. If you’re following that general canon of withdrawing 4% annually from your portfolio, adjusted for inflation, remember the ratios will change with a pullback.
For example, 4% of a $1 million account is roughly $3,300 monthly. If that account falls 20% and you don’t change the amount of dollars drawn down, you’re now looking at a 5% take down on an $800,000 account.
“Consider the longevity of your portfolio by setting a safe withdrawal rate when market valuations are low,” he says. “In a boom market, you might be more conservative.”
Yes, cash is king, particularly in times when you don’t want to sell stocks at a loss or in a downturn.
Many financial professionals suggest that investors have at least six months' worth of expenses covered (but up to a year’s worth if you want to be conservative) with cash in an emergency fund.
Though trading in the stock market has often been likened to gambling, remember that it’s not. Gambling is a zero-sum game, taking money from losers to give to winners. There’s no gain. Buying stock is an investment in a company, a piece of the action with “winnings” that will rise and fall with the fundamentals and management of the company—not to mention the overall economy. Remember, too, that the markets rise and fall.
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