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Your Safety Net

IT’S A RETIREE’S WORST NIGHTMARE: Your stocks are hammered by a market crash. Your bonds are battered by rising interest rates. Yes, you have your dividends and interest. But to get more income from your portfolio, you might be compelled to sell stocks and bonds at the worst possible time.

To avoid that nightmare scenario, which many retirees faced in late 2008 and early 2009, try dividing your portfolio in two. You might allocate 80% to a mix of stocks and riskier bonds designed to deliver healthy long-run growth. Meanwhile, consider earmarking 20% for a cash cushion that’s stashed in savings accounts, certificates of deposit, short-term bonds and similar investments. That 20% is equal to five years of portfolio withdrawals, assuming a 4% withdrawal rate.

Every year, you would pull spending money from the cash cushion. In good years for the market, you could replenish your cash cushion by selling winners from the growth portion of your portfolio. In bad years, you wouldn’t do any selling. Thanks to the five years of portfolio withdrawals in your cash cushion, you could ride out a long bear market without selling stocks and bonds at distressed prices.

To bring added predictably to this approach, you might ladder shorter-term bonds or certificates of deposit to cover your living expenses over the next five years. As you approach retirement, you would buy bonds or CDs that mature in each of the first five years of your retirement, thus providing you with the spending money you need. Thereafter, as you take gains from the growth portion of your portfolio, you might use the proceeds to buy new five-year bonds or CDs to replace those that have matured.

Don’t like the cash cushion approach? Alternatively, you might again invest for long-run growth, but ensure you have enough income from dividends, interest, annuities, pensions, Social Security and other sources to cover at least your fixed living costs. If markets crash, you might cut out discretionary spending and live solely off this income stream until you can, once again, sell stocks and bonds at reasonable prices.

Next: Four Percent Rule

Previous: Portfolio Withdrawals

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