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Thursday's 5.5% drop in the Nasdaq Composite was hard on every investor. But if you're retired or a few years away, a day like that can hit differently. You might not want to wait a decade for a rebound. And the money in your account is your future paycheck.
That worry makes sense. Spending from savings can be hard too. As TMF Financial Planning Expert Stephanie Marini puts it, "After decades of watching the balance grow, spending from it can feel like failure." But paying for retirement is what the money was for. In her words, "Selling for that purpose is the plan working."
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Picture two retirees who earn the same average return over 20 years. One hits a bad market in the first few years of retirement. The other hits it near the end. They can finish in very different places.
The reason is withdrawals. If stocks fall early on and you sell shares to pay your bills, you sell them at low prices. Those shares aren't around when the market recovers. Financial planners call this sequence-of-returns risk.
Risk tolerance is how much volatility you can stomach, Marini explains. Risk capacity is how much loss your finances can absorb. "When tolerance and capacity disagree, capacity should win for money you'll need soon," she writes.
That matters because recoveries can take years. The S&P 500 fell 56.8% between October 2007 and March 2009, then took until 2013 to regain its prior high. So the aim is to avoid being forced to sell stocks at a bad time.
One common approach is to keep three to five years' worth of planned withdrawals in cash or short-term bonds. When stocks fall, you live off that cushion instead of selling. When they recover, you refill it.
If you don't have a cushion yet, you don't need to build it all at once. You could direct dividends and new savings into cash over the coming months instead of selling stocks while prices are down.
Draw from the right accounts. TMF Financial Planning Expert Robert Brokamp says that once you're old enough for required minimum distributions (RMDs), start with the accounts that require them. Beyond RMDs, "the general rule of thumb is to take withdrawals from taxable brokerage accounts first, then traditional retirement accounts, then Roths." He adds that there are plenty of exceptions, so the best order depends on your situation.
Flex your withdrawals if you can. Taking a little less in a down year or skipping an extra like a big trip can help your savings last longer.
Keep some growth in the plan. Retirement can last 30 years or more. Most retirees still need stocks to keep up with rising prices over that many years. A cushion protects the next few years; stocks help pay for the decades after that.
Mind your RMD. If you're old enough to take one, this year's is generally due by Dec. 31. You don't always have to sell to meet it. Many providers let you move shares "in kind" from your IRA to a taxable account, so you keep the stock while still satisfying the rule. You'd still owe income tax on the value, so check with your provider or a tax professional.
If you're over 70 1/2 and charitably inclined, TMF Financial Planning Expert Amanda Kish points to another option: A qualified charitable distribution from an IRA "can satisfy charitable goals and count toward RMDs without increasing taxable income."
Everyone's situation is different, and this article isn't personal advice. If you're unsure how big your cushion should be, a fee-only financial planner can help you work it out. Decide before the next drop so your plan does the work instead of your nerves.
You can also visit GamePlan, our home base for financial planning. Its Key Milestones tab gathers guidance for members within 10 years of retirement or already retired, and its calculators can help you size your cushion.
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Retiring Soon? Don't Let a Correction Derail You. was originally published by The Motley Fool
