The S&P 500 (^GSPC -0.15%) is up year to date. So is the Dow Jones Industrial Average (^DJI -0.76%). Any talk about a bear market seems outdated after the major indexes' resurgence in recent weeks.
However, billionaire hedge fund manager Steven Cohen has warned that the S&P 500 could sink again and perhaps retest its April lows. If he's right, the stock market could again be precariously close to bear market territory.
Retirees might want to prepare just in case Cohen's prediction comes true. Here are four things they should know about retirement during a bear market.
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1. Maintain perspective
Probably the most important thing retirees should do if stocks slip into a bear market is to maintain perspective. The stock market goes up more than it goes down over the long run.
Since 1961, the average bear market has lasted around 13 months. The longest bear market during the period ran for roughly two and a half years. The shortest came at the beginning of the COVID-19 pandemic in 2020 and was over after only 33 days.
But the average bull market since 1961 lasted close to five years. The moral of the story: Time is on your side.
2. Have a cash reserve
Whether a bear market is on the way or not, it's always a good idea to have a cash reserve built up. This cash will give you a cushion you could tap if there's an extended stock market downturn.
How much cash do you need? Opinions vary, but some financial advisors recommend keeping one to two years of cash set aside.
Ideally, you'll want to have this cash in an account that pays a competitive interest rate. You could also put some of the money in short-term certificates of deposit (CDs) or short-term U.S. Treasury bonds.
3. Be aware of the sequence of return risk
Having ample cash on hand could help you reduce the sequence of return risk. This risk is that you could deplete your retirement savings too quickly by withdrawing from them early in your retirement when stocks have declined significantly.
To see how the sequence of return risk can impact your retirement, let's look at two hypothetical scenarios.
In the first scenario, you plan to withdraw $50,000 per year from a $1 million retirement account. For the first seven to 10 years of your retirement, the stock market soars with a strong bull market under way. Your retirement account grows even though you're withdrawing money regularly. The bull market eventually gives way to a bear market. However, you're still in a great position because your portfolio is larger than it was when you first retired.
Now for a not-so-rosy scenario. You again have $1 million in your retirement account and plan to withdraw $50,000 per year. This time, though, a bear market hits soon after you retire. The combination of your withdrawals and the decline of your investment portfolio increases the chances that you will run out of money sooner than you'd like.
4. Consider a flexible withdrawal strategy
How can retirees minimize the negative impact of the sequence of return risk? Consider using a flexible withdrawal strategy.
Many retirees follow the "4% rule," whereby they withdraw 4% from their retirement account each year, adjusted for inflation. However, this approach makes them more exposed to the sequence of return risk. With a flexible withdrawal strategy, you wouldn't withdraw as much from your retirement account when the stock market is down significantly.
One alternative is to instead use money from your cash reserve while stocks are in a bear market. Some retirees might look into working part-time to make enough money to reduce how much they withdraw from their retirement account. Others might reduce their discretionary spending to lower their withdrawals.
But these would only be temporary moves. Once the stock market comes back, you could then boost the amount of your withdrawals. The market will rebound sooner or later. And, as we've already seen, it typically keeps the momentum going longer than the downturns last.
