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By Jason Stipp and Christine Benz | 05-31-2012 01:00 PM

Retiree Survival Guide for Market Volatility

Retirees can gain some peace of mind by maintaining a near-term liquidity 'bucket,' reassessing their withdrawal rate, and stress-testing their equity holdings.

Jason Stipp: I am Jason Stipp for Morningstar. The market has taken a small hit over the last few weeks with plenty of uncertainty on the horizon. There is likely to be more volatility in the days ahead. Here to talk about keeping things in perspective and also how to manage through volatility in retirement is Morningstar's director of personal finance Christine Benz.

Christine, thanks for joining me.

Christine Benz: Jason, great to be here.

Stipp: So, over the last four weeks we've seen about a 6% loss in the major stock market indexes, but you have to really put that number into perspective. And you might feel a little bit better once you do so, right?

Benz: I think so. So, if you focus on your portfolio's total return and if you are nearing or in retirement, you should have a pretty balanced portfolio at that point with some cash and some bonds, as well as some equities. And what you'll see if you look at your total portfolio's return, it's probably something that's still in the black year-to-date because not only have bonds and particularly long-duration bonds performed well through this period of volatility, but also stocks have not done that poorly for the year to date. In fact, every domestic stock fund category in our database is in the black for the year to date. And even foreign-stock funds which have had bigger losses than U.S. still have not suffered double-digit losses.

So, overall, I think if you've got a diversified portfolio, chances are if you step back and look at it through that lens, you probably will be pretty pleased and not likely to be so worried about what's been going on in the near term.

Stipp: So, a couple of things the headlines always tend to do is they always focus on a narrow niche of the market that's done really well or really poorly, and they always look just over usually the recent past few weeks. So, you're never going to see a headline about how your balanced portfolio did year to date; you always are going to hear about how poorly this section of Europe did because of all the crisis over there. So, keep in mind that your portfolio is not what's in the headlines; it's these areas that are in crisis. typically.

Benz: Exactly. And this is how it nets out over time. When we hold our portfolios you do have very good periods like the first quarter and sometimes they are book-ended by lousy periods like the past month.

Stipp: So, given that you need to keep that perspective in mind, we also know that there is plenty of uncertainty out there. The Europe crisis continues to boil on. So, we know that it will probably face some volatility in the coming months. Maybe we won't, but there is always a possibility that we will see some of that market action up and down. You have a few tips for how to manage through this, especially for retirees, and this is important for retirees who obviously are much more engaged in using their portfolios.

Your first tip has to do with the bucket strategy that you've talked about so much, and specifically that liquidity bucket. What should you do in analyzing that bucket given that we could be in for a rough ride in the market?

Benz: One of the reasons I am so attracted to this bucket strategy, Jason, is because of times like this. So, the idea is that you have your near-term cash needs, your income needs, carved out in your portfolio. Those are sitting in true cash or maybe in cash plus short-term bonds, if you have a larger liquidity component. But the beauty of making sure that you have, say, one to two years worth of cash sitting in your portfolio, is that it makes you able to ride out these volatile periods in the market because you know that your near-term income needs are covered.

Not only do you have that liquidity component, but you've also got sort of your next-stage reserves in bucket number two where you've got maybe intermediate-term bonds, where the fluctuations will not be nearly so great as what you might be experiencing with that long-term equity component of your portfolio.

I do think that making sure that you do have that liquidity component there, whether you're using a total-return approach or whether you're using some sort of an income approach, in which you are periodically spilling your income and dividend distributions into that liquidity portfolio, however you're arriving at it, make sure that you have that near-term liquidity reserve set aside.

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