A Rocky Market Action Plan for Retirees

Jason Stipp: I'm Jason Stipp for Morningstar. Those who are close to retirement or in retirement may be are especially sensitive to market volatility. But there are some steps that investors can take in retirement in turbulent markets. Here to offer some tips is Morningstar's Christine Benz, our director of personal finance.

Christine, thanks for joining me.

Christine Benz: Jason, it's great to be here.

Stipp: A lot of advice you hear is not to panic and not to make unnecessary moves during turbulent markets. But there are some steps you can take--the right steps you can take--if you're in retirement during market volatility. You say the first one is check your asset allocation versus your targets. When markets are moving up and down a lot, those targets can get out of whack.

Benz: They can. I always say that people should use our X-Ray functionality in portfolio manager or use the Instant X-Ray tool to gauge your current asset classes' exposures, especially. The interesting thing is that, for some investors, they may still actually be heavy on stocks relative to their asset-allocation targets. If they've been very hands-off for the past several years and they haven't been doing any selling of their equity holdings as they've gone up and up, they might find that they are actually still somewhat overweight in stocks. So, even though you hear everywhere not to sell any stocks, for some people--retirees especially--perhaps lightening up on stocks might in fact be advisable, even though stocks have kind of lightened up themselves over the past couple of weeks.

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Stipp: But that's after many years of doing quite well. The second thing that you should do is check your cash reserves--and you are a proponent of the bucket approach. One of those buckets--bucket number one--is the cash that you're using in retirement for your day-to-day living expenses. What should I'd be looking at when I'm looking at bucket one?

Benz: You should be looking at very liquid reserves. So, you're not taking are any risks at all with this portion of the portfolio, but instead hunkering down in true cash investments--whether money market accounts, money market funds, or CDs even. The basic idea is that you are using this money to provide your ongoing living expenses; you don't want this bucket one to be too large--anywhere from, I would say, six months' to two years' worth of living expenses that you'll need to draw from your portfolio above and beyond what you're getting from Social Security and pension. But you hold that money aside in cash to provide some peace of mind in markets like this one. That's really the value of the bucket strategy: You know that stocks could stay down for a while here, but [there's peace of mind in knowing that] things would need to get worse before I need to invade any of my longer-term securities. In fact, the idea is that you will not have to touch your long-term securities--you can let them recover.

Stipp: But you shouldn't overfill bucket one. You might have that tendency to want to really load up on cash at this time because the markets are so volatile, but there's a big downside to that potentially.

Benz: There is. There is a big opportunity cost with cash in that cash yields are still very, very low today. And the other thing that we've seen just during this recent period of volatility is that we've actually seen intermediate-term bonds have gains, not big gains but some gains. That's not something you're going to see as a CD investor in times like this. Your return will remain very, very low, whereas good-quality bonds--say, intermediate-term bonds--have the potential to gain a little bit in times like this.

Stipp: Another possible use for cash is as dry powder for opportunistic-type investing. But if I'm looking for bargains, maybe I should be pretty particular in what I choose at this time.

Benz: Right. When you look across the equity universe, really everything is beaten down right now--no matter what the sector. But some of the most intriguing opportunities, the things that have fallen the furthest, the things that have the most attractive price/fair values according to our equity analysts are some really cyclical names. Some of the energy companies, of course; some of the basic-materials names; companies with quite a lot of risk attached to them.

So, retirees, I think, should do bargain-hunting just like anyone else, but they should make sure that they have appropriately long time horizons. They should also make sure that they are being diversified in terms of pursuing opportunities. I think a good value-oriented fund can do this job for you; but if you are stock-picker and you are looking for individual stocks that are beaten down, definitely plan to buy a little basket of them versus syncing all of your opportunistic money into a single name.

Stipp: Another side to retirement success involves spending. And when markets are volatile, it could be a good time to make sure that you are spending wisely. You don't want to overspend anytime, really, but especially when markets are bad.

Benz: Right. A lot of the retirement research that looks at sustainability of withdrawal rates finds that retirees who overspend in periods when their assets are down can deal their portfolios a blow from which they never recover. So, the basic idea is that if you can be somewhat variable in terms of what you withdraw from your portfolio and, specifically, take less in those down markets, that can be one of the best ways to improve the sustainability of your portfolio over the long run.

So, I don't think there is need for retirees to undertake any radical belt-tightening. At this point, the market sell-off has not been that bad. 2008 certainly would have been the type of downturn where such belt-tightening would be very, very advisable. But I still think it makes sense to see whether there are some areas in the budget where maybe because you've gotten used to your equity portfolio growing and been maybe spending a little bit more in these past few years, maybe you can see if you can trim some of those expenses. At a minimum, if you are using the classic 4% rule strategy--where you took 4% initially in year one of retirement and then you're giving yourself a little bit of an inflationary raise--as the years go by, you could simply forgo that inflation adjustment for 2016. That, too, has some merit as a way to improve your portfolio sustainability. T. Rowe Price did some great research during the financial downturn that pointed to just simply forgoing that inflation adjustment as being a way to boost a retirement portfolio's sustainability.

Stipp: And lastly, a down market can present some opportunities potentially for some good tax planning. What things should I have on my radar there?

Benz: A couple of things. Certainly, if you have taxable accounts, you can look into whether you can potentially do some tax-loss selling. Of course, you can't use those tax losses for your 2015 return. But if you do tax-loss selling here in 2016's early innings, you'll be able to harvest some losses that you can use to offset capital gains elsewhere in your portfolio. Or if your losses exceed your capital gains, you can use them to offset up to $3,000 in ordinary income in 2016.

So, that's one strategy certainly to consider for your taxable accounts. You might also take a look at Roth conversions. If you are someone with a big traditional IRA kitty--and this is especially appropriate for retirees who don't need it but maybe want to pass it to heirs--they might, in fact, do some conversions during retirement. It tends to be the most advantageous to do the conversions when your balance is down because you are paying taxes on that portfolio balance at the time you do the conversion.

So, generally speaking, downturns present pretty good opportunities to mull conversions. Definitely check with the tax advisor, I always say, before undertaking any conversions.

Stipp: Christine, thanks for talking about these smart ways in which investors in retirement can deal with market volatility.

Benz: Jason, thank you.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.