The beginning of 2016 has been a trying time for investors.
The recent volatile markets are garnering the attention of retirees, many of whom are wondering how their retirement income plans will weather the current economic trends. The American College of Financial Services conducted the RICP Volatility Flash Survey, in which it questioned advisors designated as Retirement Income Certified Professionals (RICPs). The results showed that more than 60 percent of RICPs’ clients had reached out for advice more frequently than usual during periods of recent market volatility. Retirees are right to be concerned about market volatility, as it presents a very real risk to their retirement security.
The survey found 60 percent of advisors also reported that none of their clients had made changes to their retirement plans during this time of market turbulence. This was despite the fact that more than half of the advisors found that their clients are more concerned about retirement security than they were last year.
With volatile markets at the doorstep, let’s take a closer look at four additional planning strategies that can reduce the impact of volatile markets on a retiree’s retirement income plan.
1) Reduce Withdrawal Rates
Most retirees need to sell assets in their investment portfolio in order to generate the income needed to meet their retirement expenses. Taking withdrawals from a retirement income portfolio can subject the retiree to sequencing of returns risk. The risk is that if the retirement portfolio experiences negative returns early in retirement, the retiree’s withdrawals will be too high to be sustainable throughout retirement. However, if the retiree can be flexible with spending during volatile or down market years, the longevity of the portfolio can be improved substantially by reducing the withdrawal rate.
2) Reduce Portfolio Volatility
While market risk cannot be entirely eliminated through stock diversification, the portfolio’s volatility can be reduced by diversifying among different industries and by including additional asset classes in the investment portfolio. This means the portfolio should contain some defensive stocks — stocks such as health care and consumer staple stocks that do well in down markets. In addition, the portfolio should contain some growth-oriented stocks, such as technology stocks, that tend to do well in expanding economies. Adding asset classes such as commodities, real estate, international stocks and small-cap stocks can reduce the standard deviation of a portfolio and thereby reduce its overall volatility.
3) Incorporate Downside Protections
Another strategy that can reduce the impact of market volatility on a retirement income plan is to make sure downside protections are built into the plan at the time of its development. Downside protections can include purchasing put options through the first five years of retirement. A put option gives the holder the right, but not the obligation, to sell an underlying asset at a set price during a specified time period. However, using put options throughout the entire retirement period is often a bad idea, as it limits the potential growth of the portfolio. Additionally, a variable annuity with a guaranteed living withdrawal benefit rider could be incorporated into the plan to create a guaranteed retirement income floor with some upside potential. Furthermore, low-risk investments can be used to meet short-term retirement expenses by engaging in asset liability matching.
4) Tap Into Nonmarket-Correlated Assets
Another way to limit the impact of volatile markets on a retirement income plan is to tap into assets that are not correlated to the market in order to generate income as an alternative to selling stocks. One strategy is to hold cash reserves to help cover early retirement expenses. However, be careful not to hold too much in cash, as it can be detrimental to retirement security in the long run. Other nonmarket-correlated income sources include tapping into home equity with a reverse mortgage. A reverse mortgage can be an effective way to generate income in the early years of retirement and put off having to sell investments when the market is down. Finally, cash value life insurance can be an effective way to meet income needs early in retirement, as the cash value is not impacted by market fluctuations and usually can be accessed without any negative income tax implications.
The recent volatile markets should serve as a wake-up call for those nearing or already in retirement without a comprehensive retirement income plan in place. Skilled retirement income advisors need to take their clients’ concerns about market volatility seriously and make sure their clients’ retirement income plans are well-equipped to handle market volatility.