Financial Planning Fridays #5: A Key Way to Manage Risk

Today we will discuss another way to measure risk in your portfolio, which becomes especially important once you are retired.

Here at Presilium, we measure risk by looking at the amount of retirement income you’ll need each year and comparing that to what is currently held in short-term bonds and cash.

Said another way, in the event of a major market downturn, how many years could we continue to draw income from your investment accounts to cover your spending goals before having to sell stock?

Typically, we recommend, and work towards, having at least five years’ worth of retirement spending in relatively stable investments, like short-term bonds and cash.

For example: if your goal is to spend $100,000 per year in retirement and you wanted to keep a five-year cushion before having to sell stock, then you would need to keep $500,000 in short-term bonds at all times.

There are a few reasons why we think about it this way:

  1. There have been 26 bear markets since 1928. They happen about every three-to-four years and the average decline has been about 35%. The average recovery time for stocks to get back to even after a bear market is about 2.5 years. As most people know, it is during these major market downturns that it is incredibly important to not find yourself in a position to have to sell stock for a major purchase or to fund your retirement lifestyle. If we have worked to be in a position where we have five years or more of retirement spending built up in very secure, very stable short-term bonds and cash, then we should never be in a position to have to sell stock. In addition you should never have to alter your retirement lifestyle or spending simply because we are in a bear market.
  2. Now that we have addressed the safety buffer, it is also important to address another important form of risk: inflation or longevity risk, which is the risk of outliving your money. Another reason we feel so strongly about building up this security buffer in short-term investments is because once this is established, it allows you to invest more fully in stocks for the long-term with the remaining portion of your portfolio. By doing this within a properly diversified portfolio, we ensure that you are able to maintain a comfortable lifestyle amidst any market volatility, but also that your accounts will continue to grow, and outpace inflation for you, over what is hopefully a 30-40 year retirement.

We think the best way to determine what size buffer and investment allocation is right for you and your goals is to start with a long-term financial plan that we then use as a guide to answer these questions. We have found that clients feel much better weathering down markets if they know how much of a spending reserve they currently hold before they would ever have to sell stocks.

Please feel free to reach out to us with questions on how this specifically relates to your financial plan.

Thank you for joining us today.

In our next video in this series, we will review from which accounts to take withdrawals from, and when, once you retire. This can have a huge impact on your financial plan.

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For our clients that are retired, we like to keep at least 5 year’s worth of the income needed in bonds. This way we know that they have a cushion to draw from anytime the market is temporarily down.

In fact, one of the ways that we measure risk is not by looking at your stock to bond percentages, which we feel may leave you exposed to inflationary risks, but by looking at how many years of expenses we could cover with your current bond holdings.

5 years is a great starting place but we have clients that keep 10-15 years worth of retirement income in bonds. We then feel confident investing the rest of the portfolio in stock where the chance of gain over 5 years is 88% and much higher over longer periods of time.

Be on the lookout for our next Financial Planning Fridays episode. Subscribe to our Youtube Channel so you never miss an episode. Or contact us directly; schedule your 15-minute call with us today.