How to Prevent a Retirement Implosion

After spending a lifetime saving money for your retirement, hitting the finish line having reached your financial goals may make you think it's time for a victory lap. But even if you think you've saved enough for a comfortable retirement, you're not out of the woods yet.

Once you retire, you face a new challenge with your money: How to make it last. Although there are some rules of thumb to help guide you in how much of your nest egg you can afford to spend over time, the whims of the stock market can turn what seemed like an endless supply of money into a whole lot less a whole lot faster than you'd think.

The threat of early losses
In the brand-new issue of the Fool's retirement newsletter, Rule Your Retirement, Foolish retirement expert Robert Brokamp addresses all of the issues that retirees have to deal with as they try to preserve their retirement savings as long as possible. Keeping spending under control, dealing with the possibility of a long lifespan, and addressing inflation and costly investment mistakes are all ways that you can handle your retirement finances, and Robert has some useful tips on each of them.

One of the things you can't control, though, is how your investments perform. If you've handled your own investments for a lifetime, then you're already quite familiar with the fact that markets rise and fall. Over the long run, though, those bumps in the road even out to reasonable growth.

But at least in one respect, that long-term focus has to change in retirement. As it turns out, facing a down market early in your retired years can adversely affect your finances for the rest of your life.

Smart withdrawals
In his article in Rule Your Retirement, Robert talks with Jim Otar, a Certified Financial Planner and expert on how retirees should withdraw money from their nest eggs. Otar points out that after a 20% drop in your portfolio, you'll need to earn 25% to break even. But if you're making 4% withdrawals every year, you'll need a 42% total return over three years to get back to where you were.

Otar suggests a couple of solutions: owning a diversified portfolio with at least half of your assets outside of the stock market, and cutting your spending should you run into a bear market just after you retire. Also, by keeping a cash cushion to cover your expenses, you can ensure that you won't have to liquidate stocks at exactly the wrong time.

Another option?
Let me add a suggestion of my own. Those experienced investors who are open to alternatives might want to consider a couple of strategies involving options. By providing protection for the first two or three years, certain options strategies can get you through that crucial initial period for your stock portfolio.

One strategy is to buy long-term put options that would protect you from market downturns. These options guarantee that you'll get a minimum price for your shares no matter how far the market price drops.

The downside of that method, though, is that it's expensive. Consider the cost of such a strategy for these commonly held stocks:

Source: Yahoo! Finance.
Price for closest out-of-the-money put option expiring January 2012.

That's a lot. If you could afford to spend 10%-20% on put options, you probably wouldn't need them in the first place. So that strategy doesn't work well for many people.

Another choice, though, is to write long-term covered call options on shares you own. You limit your upside, but you can get a bigger stream of income upfront. Take a look at these examples:

Source: Yahoo! Finance.
Price for call option with closest strike price expiring January 2012.

By writing a call option, you keep that rich upfront payout. Even if your stocks go on, what you get when you write the option can offset your losses. And if the option gets exercised, then you're selling stock that you might well have sold anyway for living expenses.

Retire smart
Whether you use options or less complex strategies, protecting your retirement nest egg is essential. With the right help, though, you can minimize the risks and ensure a comfortable retirement for yourself.

Read the whole article with Jim Otar and much more in the latest issue of Rule Your Retirement. It's available free with a 30-day trial that you can start by clicking here.