First things first: The stock market is not in a bear market -- at least not the entire stock market. To officially be in bear market territory, stocks would need to be at least 20% below their previous high. As of now, neither the S&P 500 (^GSPC 0.61%) nor the Dow Jones Industrial Average (^DJI 0.26%) have fallen that much.
Sooner or later, though, a bear market will arrive. The prospects of a full-blown global trade war could increase the chances that this eventuality comes sooner than anyone would like.
Regardless of the timing, anyone who is retired or will soon retire should be ready. Here are four things retirees should know about retirement in a bear market.
Image source: Getty Images.
1. Don't panic
Most importantly, don't panic. Bear markets aren't the end of the world. The S&P 500 has experienced 22 bear markets since 1928, according to Yardeni Research. We've had four bear markets so far this century.
And there's some good news: Bear markets typically don't last all that long. The average bear market duration is 409 days with an average maximum decline of 36%. However, the average bull market lasts 1,866 days with the S&P 500 soaring around 180%.
With this perspective in mind, panic selling doesn't pay off. Investors who don't panic should have short-term pain but long-term gain.
2. Be aware of the sequence of return risk
However, retirees should be aware of a potential issue during bear markets. It's called the sequence of return risk. The risk is that withdrawing from your retirement accounts when stocks have fallen significantly can cause you to burn through your money faster than you'd like.
Let's look at two scenarios to understand how the sequence of return risk can hurt you during retirement.
In the first scenario, a person retires with $1 million. She intends to withdraw $50,000 per year. In the first years of her retirement, the stock market booms. Her investment portfolio grows even though she's withdrawing money each year. A bear market comes later in her retirement, but she's in a better position to weather the storm because her portfolio is larger.
Now for the second scenario. Again, a person retires with $1 million and plans to withdraw $50,000 each year. However, a bear market comes early in his retirement. His investment portfolio takes a big hit, with the withdrawals causing it to decrease even more. He is more likely to run out of money sooner than the person in the first scenario because of the unfortunate timing of when stocks entered a bear market.
3. Evaluate your withdrawal strategy
What can you do to minimize the sequence of return risk? Evaluate your withdrawal strategy.
If at all possible, don't withdraw as much from your retirement accounts during a bear market. Maybe you could work part-time to supplement your income to reduce your withdrawals. Another alternative is to reduce discretionary spending. For example, you might delay a costly vacation you planned to take. Adjusting your withdrawals and spending based on how your portfolio is performing can make your money last longer.
Which retirement accounts you withdraw from is critical, too. You can minimize your taxes (and potentially lower your withdrawal amounts) by taking money out of tax-free accounts, such as Roth IRAs. If you have funds in fully taxable accounts, consider selling your biggest losers for tax-loss harvesting.
4. Diversify
Portfolio diversification is always important. However, it's especially critical to diversify your retirement portfolio before a bear market comes.
Your financial advisor can help you diversify your money in the best way to meet your needs. Generally speaking, you'll want to have a portion of your investments in more stable assets, such as bonds, that are likely to hold up well when stocks decline. However, foregoing stocks entirely isn't wise because stocks typically outperform most other assets over the long term.
