The stock market is seeing tremendous volatility and nearly a 25% decline in
value in recent weeks due to the economic uncertainty caused by the rapid spread of the COVID-19 virus. Businesses are laying off workers and unemployment claims are spiking. Many people feel less financially secure than they did just a few weeks ago, especially those who recently retired. A recent retiree planning to live on 4% annual withdrawals* from their retirement portfolio consisting of stocks and bonds should consider making major changes right now. If this retiree continues annual withdrawals from their portfolio while stocks are in decline they run the risk of shortening the life of their portfolio and possibly running out of money in their lifetime.
Below are some action steps you can take now to preserve your retirement fund and navigate this recession:
1. Act Now, Don’t Wait: Experts may make predictions, but no one really knows how long this recession is going to last. It could be just a few months or well over a year, but you can’t just wait to find out. You need to create a plan and implement it immediately because time is not on your side. Your options become more limited the longer you wait. But, also don’t panic. This is not a time for rash decisions, take a deep breath and write down your strategy to navigate this recession while suspending most or preferably all the withdrawals from your retirement portfolio.
2. Look for Work, Today: You may have just retired and planned to relax, but now its time to get back in the game. You need to bring in some income to help reduce your withdrawals from your portfolio. If you can immediately go back to work full-time that is great, but if not, don’t hold out for full-time work. Start with a part-time job as you search for full-time positions and if possible take two part-time jobs. As you look for full-time work, begin with your former employer. If you left on good terms they may have some work you can do as a consultant or some higher paying part-time worker. Don’t try to ride out the recession for a month or two and then look for a job because jobs are going to become much harder to find as the recession worsens. Also the longer you are unemployed the less marketable you may become.
3. Reduce Your Monthly Expenses: As covered in the book Become Loaded for Life, your five main spending categories, accounting for two-thirds of household spending, are housing, transportation, health care, food and entertainment. If this is where you spend the most money it is also where you can save the most.
To reduce housing expenses consider renting part of your housing on a home sharing site like AirBnB or temporarily move in with a friend and pay them rent while you rent out your entire house. This option will help both of you during the downturn.
If you really don’t need a car, maybe now is the time to sell it before the recession deepens and there is less of a market for used cars. Cutting health care costs may be harder depending on your circumstances but see if there are any steps you can take to reduce your spending in this category. Food and entertainment are easier to cut. Skip eating in restaurants or paying for take out and look for ways to stretch your dollars at the grocery store. Look for coupons if that is not something you usually do and select less expensive brands. Every dollar counts. Also look to see if you can drop any monthly entertainment expenses or monthly services to shrink your budget. Remember all this belt tightening is temporary as you are just trying to get through the recession to allow your portfolio to recover from such a sharp sell off.
4. Defer Major Expenses: If you were looking to help pay for a family member’s college education, take a major vacation, or put a new roof on the house, now is not the time. You will have to defer these expenses until after the recession. If you need to help pay for college, it is better cosign on a student loan or take out a student loan at low interest rates than it is to sell stocks that declined by 25% in value. That will just lock in your losses. Your primary goal is to suspend the withdrawals from your portfolio so you should not be selling any stocks to fund living expenses.
5. This is an Opportunity: Once your defensive efforts to lower expenses and increase your income are successful, you can suspend most, if not all, your withdrawals. Now it is time to play offense. This is a great time to prosper in this downturn. I firmly believe most wealth is created in economic downturns, as fear creates opportunities.
Any extra income you can earn or save should be invested in a broad index of stocks. You don’t know when the stock market is going to hit bottom so start buying in at regular intervals and continue to make these small incremental investments throughout the downturn. This allows you to pick up shares at a discount and significantly strengthening your portfolio when the stock market recovers.
Another way to prosper is to consider refinancing your house. As the economy declines the government will usually lower interest rates which can lead to lower mortgage rates. Refinancing may lower your monthly mortgage payments. If your home is paid off you can consider a line of credit to gain access to funds at a relatively low interest rate. You may want to consider taking some of this money and invest in stocks. If stocks have an average return over the long term of 10% and you are borrowing on a line of credit at 5%, you will end up with a sizable return over the years.
6. Learn to Prepare: All markets work in cycles; several good years are followed by some form of downturn. The time to plan for these types of downturns is during the good years. The COVID-19 pandemic is a bit of an economic black swan event and is relatively hard to predict. However, stocks in the United States have been on an 11-year bull market run. We were already overdue for a correction in stock prices; if it wasn't coronavirus, it could have been any number of other factors to spark a sell off in stocks.
One way to protect yourself is to re-balance your portfolio on a yearly basis so you don't diverge too far away from your desired mix of 60% stocks and 40% bonds. A second way to protect yourself is to maintain a cash reserve equivalent to six-months of your basic living expenses. A very detailed explanation of this strategy is covered in Become Loaded for Life. This strategy provides an immediate cash reserve and the ability to suspend withdrawals from your retirement portfolio.
Globally we are in a scary time as countries wrestle with the challenges of containing this deadly virus through quarantines and try to provide proper medical care for their citizens. It is also a time when economies seem to be crumbling and countries race to provide economic stimulus. But, remember we will get through this. We are stronger than COVID-19, so stay safe, be kind and look for ways to learn from this experience.
*This example assumes our retiree is relying heavily on a portfolio of 60% stocks and 40% bonds in a tax deferred retirement account and does not have other forms of retirement income such as rents from rental properties, annuities, or a private pension. Even if you have a more diversified portfolio, these strategies can still be valuable even if you have some other income sources. To ensure you will never be in this situation see the sections on stress testing your retirement portfolios in Become Loaded for Life and the 10 Stages Workbook available on this website.
