One of the biggest fears among workers and seniors alike is the notion of running out of money in retirement. That danger becomes all the more real if the market happens to take a tumble early on during your golden years.
The reason? Say you enter retirement with a $1 million nest egg and need to start withdrawing from it right away to pay the bills. Let's also assume you're planning to use the 4% rule, which has long been the standard annual withdrawal rate, to give yourself about $40,000 a year in income.
But what if the market tanks and your portfolio value drops 10% right as you retire? At that point, you'll suddenly have just $900,000 in savings to work with. This means that you'll either have to manage on a smaller yearly income (if you stick with that 4% withdrawal rate, you'll get just $36,000 a year instead of $40,000) or risk depleting your savings prematurely by giving yourself the full $40,000 you were initially planning on. Furthermore, any money you remove from your savings can no longer be reinvested for growth for the rest of your retirement, so withdrawing during a market downturn would make it harder for your nest egg to recover -- a double whammy, if you will.
That's why it's crucial to protect yourself from a possible market downturn during the early stages of your retirement. And here's how to do it.
1. Diversify your investments
Though diversifying your holdings may not help you avoid investment losses, it can help keep those losses to a minimum. So take a look at your assets and make sure you're not overly invested in a particular segment of the market, because you never know when a single sector might take a particularly hard hit during a downturn. Similarly, be sure to have a healthy mix of stocks and bonds in your portfolio -- ideally dividend stocks, which will often manage to keep making quarterly payments even when the market is underperforming.
2. Have emergency savings
Having emergency cash reserves is important at any stage of life, but when you're looking at a market downturn early on in retirement, it becomes all the more critical. Having money in the bank might help you limit the extent to which you're forced to withdraw from your nest egg during a period of decline, thereby preserving your savings and giving your investments a chance to recover. Of course, you don't want to deplete your cash savings to pay for basic living expenses, because you do need some money on hand for actual emergencies. But having a healthy bank account balance will buy you the option to leave your investments alone while you ride out the storm.
3. Establish a backup income stream
The more options you have for generating cash in retirement, the less you'll need to rely on your nest egg -- which can certainly come in handy when the market takes a tumble. That's why it pays to secure a few backup income streams to protect yourself against a significant downturn. Most seniors will get some money from Social Security, so there's that, but since you can't live on those benefits alone, you'll need to figure out other ways to pay the bills without heavily tapping your savings. Your options include getting a part-time job, starting a business, or renting out part of your home. The key is to figure out what's most viable for you and prepare to jump on that option as needed.
4. Secure a home equity line of credit
If you own a home going into retirement, applying for a home equity line of credit (HELOC) might help you salvage your nest egg in the event of a market downturn. As the name implies, a HELOC allows you to borrow money against your home's equity, but unlike a home equity loan, where you're taking out a lump sum, a HELOC simply gives you access to money that you can use as needed. With a HELOC, you'll get the option to withdraw cash to pay your living expenses without tapping your nest egg and taking losses during a major downturn. And though it's not a perfect solution, it's a solid backup to put in place.
Unfortunately, there's no telling when the next major market downturn will hit, but if you're looking to retire in the near future, it pays to devise a plan for coping with it. The last thing you want is to kick off retirement on a rocky note, and while you can't control the market, you can take steps to protect yourself from a negative turn of events.
The Motley Fool has a disclosure policy.