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Retiring in a Bear Market

April 6th, 2020 | 4 min. read

By Jacob Schroeder

bear market retirement

There’s no need to mince words. It is a nightmare scenario for anyone nearing retirement. You diligently save and invest over a long career only to find yourself potentially retiring in a bear market.

Now, what?

One of your primary sources of income will consist of your retirement savings accounts, such as 401(k)s and IRAs. Withdrawing money from those accounts while they’re down can negatively affect the longevity of your portfolio. 

However, the unfortunate circumstances of a bear market doesn’t mean all is lost. While it’s not the ideal investment environment for transitioning into retirement, market declines of 20% or more are nothing new. The S&P 500 has experienced nine bear markets since 1949, with an average total return of -33% and duration of 14 months, according to Capital Group.

So, the possibility of a bear market should already be factored into your retirement plan. (If you don’t have a retirement plan, then start here.)

You can’t control the direction of the market, which is okay. Because the things you can control will help keep your retirement goals in place. Which options are best for you will depend on your personal situation, including your savings, age and estimated retirement needs.

Use your emergency fund and cash reserves

An important reason to build an emergency fund and cash reserves is to buy your portfolio time to recover. In retirement, it makes sense to have one to two years’ worth of expenses in cash accounts and liquid cash investments, such as savings and checking accounts, money market funds and CDs. That money, coupled with other income sources, could help cover your basic needs without you having to dramatically adjust your investments or desired retirement lifestyle.

Stay invested in stocks

The farther along your investment journey, the less you typically should have invested in stocks. After all, by the time you retire, your investment goal shifts from growing to preserving your savings. However, you should never consider cashing out of stocks completely, especially in a bear market.

For one, the stock market has historically always recovered. We just can’t predict when. And, the biggest gains often happen early in the recovery period. Dating back to 1929, on average, returns in the first year after the five biggest market declines equaled nearly 71%.

Additionally, retirement could last 20 to 30 years, which means your savings need to keep pace with inflation. Using the historical average rate of inflation, 3%, your purchasing power could be cut in half over that time period. The higher expected returns of stocks compared to other investments make them better suited as a means for inflation protection.

Adjust your withdrawal rate

How much you plan to withdraw from your retirement accounts is a personal choice, depending on factors such as your level of wealth, annual expenses, sources of guaranteed income (pensions, Social Security, etc.) and age when you retire. A common starting point is withdrawing 4% of your portfolio, adjusted for inflation each year.

For everyone though, the math is the same. The higher your rate, the lower the chances your portfolio will last throughout retirement. One way to bypass that danger is to maintain a flexible withdrawal rate, which can improve your portfolio’s longevity. By taking modestly lower withdrawals, if possible, in those beginning weak years, you can help preserve some of your balance and give it time to recover. It also puts you in position to possibly spend more during those future strong years.

Reevaluate your Social Security strategy

Those who plan to delay Social Security in order to maximize their benefit may want to at least take a second look. By waiting to file, you can increase your benefit by up to 8% per year until age 70.

But, while you wait, you may be relying on your portfolio for your income needs. In a down market, that might be putting too much stress on your portfolio. Therefore, it might make sense to consider claiming Social Security earlier than planned to have an additional income stream as your portfolio recovers.

Take advantage of potential tax savings

When a bear market gives you lemons, you can make tax lemonade.

One option is to lower your taxable income by selling losing investments from your taxable account. This is known as tax-loss harvesting. When properly done, you can sell investments that have lost value to offset up to $3,000 in ordinary income.

Further, with lower stock prices, it may be a good time for a Roth conversion. That is, transfer some or all your funds from a traditional IRA to a Roth IRA. Withdrawals from Roth IRAs are tax-free, and Roth accounts are not subject to RMDs. A Roth conversion is a taxable event, in which you pay taxes on the money you rollover that you haven’t paid taxes on before. Since you would be converting a lower balance because of the market downturn, your conversion taxes would be lower as well.

There are a variety of tax rules to navigate here, so these moves are best done with the guidance of a tax or financial professional to avoid triggering any unnecessary taxes.

Find ways to lower your investment costs

Another thing that is directly in your control is the amount you pay in investment costs, including fund fees for the investments themselves and what you pay to have your money managed. Lowering these costs can make a major difference over time, in both up and down markets.

The more you pay in fees, the less of your return you get to keep. An investor with a $25,000 portfolio balance earning an average 7% return paying 0.5% in fees can expect it to grow to $227,000 in 35 years. If that same investor paid 1.5% in fees, the balance would grow to only $163,000. Just a 1% increase in fees in this case is a difference of $64,000.

Delay retirement

It’s probably the least attractive option. But, if it’s possible to stay in the workforce, it may be the surest option. Remember, it takes on average a little over a year for the market to recoup its losses, so working just one year longer could significantly help your investment accounts recover and keep you from having to consider spending less in retirement.

The bad news is a bear market will likely impact your retirement plan. The good news is that you have options to manage its impact. Which ones work best for you depend on your personal situation, so talk it over with a financial adviser.

There’s always a chance for a bear market every decade. But you don’t need to let this bear market ruin your one chance at retirement.