How to Prepare for a Market Crash Early in Your Retirement

5 keys to preparing your retirement plan to withstand a stock market crash.

As you step into retirement, one of the biggest concerns you might face is the potential for a market crash right at the start. It’s a valid worry—after all, you’ve spent decades saving and investing to secure your future. The last thing you want is for a sudden downturn to wipe out a significant portion of your nest egg. Today, I want to dive into how you can prepare for this possibility and safeguard your retirement savings.

Understanding Sequence of Return Risk

One of the most critical concepts to grasp is something called “sequence of return risk.” It’s a fancy way of saying that the order in which you experience returns matters, especially when you’re withdrawing money in retirement. Even if your investments average 8% over time, a few bad years early on could have a disproportionately negative impact if you’re taking withdrawals at the same time.

Imagine this: you have a few great years of returns, followed by a significant loss. If those losses happen early in retirement, you’ll have less money left to recover and take advantage of potential gains down the road. This is why the timing of returns can make or break your retirement plan. When you’re adding money to your account during your working years, market downturns aren’t as concerning—after all, you’re buying shares at a discount. But once you start drawing down, those downturns can be devastating.

Implementing a Bucketing Strategy

One popular way to mitigate this risk is through a bucketing strategy. This involves dividing your investments into different “buckets” based on when you’ll need the money. You might have a cash bucket for the first few years of retirement, which isn’t exposed to the stock market’s ups and downs. Then, you’d have a growth bucket for long-term needs that can ride out the market’s volatility.

The key question is: how much should you keep in each bucket? It’s helpful to think in terms of years rather than months. For example, many experts suggest having at least three to six months’ worth of expenses in your cash bucket as an emergency fund. For your retirement plan, we take the conventional suggestion of “months” for an emergency fund and turn it into “years” for retirement. 

Back in 2008, Warren Buffett famously advised that if you need money in the next five years, keep it safe in the bank. For money you won’t need for five years or more, keep it invested. The five-year mark is a useful rule of thumb because it took about five years for the stock market to recover from the dip it took after its 2007 peak. When you hit retirement you can adjust how much you have in safer assets based on the level of risk you want to take.

Adjusting Your Investments Proactively

Another way to prepare for a potential market crash is by adjusting your investment portfolio before you retire. As you approach retirement, you might want to gradually reduce your exposure to riskier assets like stocks and increase your holdings in safer investments.

For example, if you’re planning to retire in five years and your goal is to have seven years’ worth of expenses in your cash bucket by then, start shifting money gradually. Don’t wait until the last minute or after the market drops to make these adjustments. It’s all about being proactive rather than reactive.

Be Flexible with Your Withdrawals

Flexibility is another crucial element. The traditional 4% rule, which suggests withdrawing 4% of your portfolio annually, adjusting for inflation, works well—in theory. However, if the market crashes, sticking rigidly to this rule could mean taking withdrawals at the worst possible time.

Instead, consider adjusting your withdrawals based on market conditions. If your investments have had a good year, you might take a bit more. If they’ve had a bad year, tighten your belt and take out a little less. By being flexible, you can stretch your savings further and give your investments more time to recover.

Borrow Money to Live On

It might sound counterintuitive, but borrowing money during a market downturn could be better than selling investments at a loss. For example, you could borrow against your cash value life insurance policy, tap into a home equity line of credit, or even borrow from yourself by drawing from a savings account that you intended to keep intact.

The idea here is to give your investments time to rebound. Once the market recovers, you can repay the borrowed funds. It’s a strategy that requires careful planning and a solid understanding of your financial situation, but it can be a creative and powerful tool to protect yourself in the right circumstances.

Build Your Guaranteed Income

Finally, having a source of guaranteed income can provide peace of mind during market turbulence. This could come from Social Security, a pension, or even an annuity. Research shows that retirees with guaranteed income streams feel more comfortable spending their money and are less stressed during market downturns.

When you know that a portion of your income is secure, regardless of market conditions, it can make it easier to stick to your investment plan and avoid panic selling.

Conclusion

Market crashes are an inevitable part of investing, but they don’t have to derail your retirement. By implementing strategies like bucketing, adjusting your investments, being flexible with withdrawals, considering strategic borrowing, and building guaranteed income, you can create a robust plan that helps you weather the storm.

The goal isn’t to predict when a market crash will happen—it’s to be prepared for when it does. With the right approach, you can turn the uncertainty of the markets into an opportunity to strengthen your retirement plan and ensure that your savings last as long as you need them.

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Additional Links:

• “Safety-First Retirement Planning” with Wade Pfau – Retirement Revealed episode #141
• “7 Pro Tips for More Dynamic Retirement Planning” with Justin Fitzpatrick – Retirement Revealed episode #70
• “Make Your Retirement Savings Last” – AARP Magazine

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