There's a reason so many people are scared to invest their retirement savings. The stock market has a long history of being volatile. And it's a highly unpleasant thing to see your portfolio balance drop 5% or 10% over the course of a single week, which isn't such an uncommon occurrence.
But as scary as stock market crashes can be ahead of retirement, they can be even more problematic once you're in retirement. That's because at that point, you aren't trying to accumulate wealth for the future. Rather, you're actively using your IRA or 401(k) for income.
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If you're forced to sell investments at a loss during retirement, you risk depleting your savings in your lifetime. And even if that doesn't happen, your portfolio's value could drop substantially. But one important move on your part could prevent a host of negative consequences in the event of a stock market crash during retirement.
Having a cash cushion is key
It's definitely not a good idea to keep all of your retirement savings in cash. You need that money to continue growing to support a decent withdrawal rate.
But one of the best ways to protect your portfolio from a mid-retirement stock market crash is to stockpile cash for that sort of event. If you build a cash cushion, you'll have the option to leave your portfolio untouched during a market decline, thereby avoiding losses.
How much of a cash cushion should you build? That should depend on a few factors:
- Your annual living expenses
- Your willingness and ability to cut spending in a market downturn
- Your desire for peace of mind
Let's say you expect to tap your portfolio to the tune of $90,000 a year. Let's also assume that you don't want to be forced to reduce your spending during a market crash, and that you tend to err on the side of being nervous when markets are rocky.
In that scenario, a three-year cash cushion, or $270,000 worth of cash, may be appropriate. That gives you a fairly long time to leave your portfolio untouched while you wait for your investments to recover from a market crash.
On the other hand, let's say you typically withdraw $120,000 a year from your savings, but $20,000 of that is allocated to travel. If you're willing to scale back significantly in that spending category during a market downturn, and you're not overly worried about stock market recoveries, then you may decide to keep about $200,000 in cash on hand.
A simple move with a big impact
Keeping too much money in cash as a retiree could stunt your portfolio's growth. But as a general rule of thumb, keeping two to three years of expenses in cash is a great way to protect your portfolio in the face of market volatility.
