What retirees can do during a market downturn
1. Put feedback in context
First and foremost, we need to get past the fight or flight impulse to react to market losses. A portfolio designed using Liquidity. Longevity. Legacy. framework is segmented into three key strategies based on specific needs and time horizons.
Wealth segmentation by purpose helps clarify that the money you need to spend today is safe. And, while your long-term investments may have temporarily diminished, our bear market research tells us that those losses will likely be fully recouped by the time those assets are needed.
This approach helps reinforce that market losses are short-lived and also represent an opportunity for investment for future spending.
2. Do not recharge your liquidity strategy
A well-funded liquidity strategy can help protect your retirement plan against sequence risk because it allows you to meet your needs today without being forced to sell assets at declining prices.
We recommend that you fund your liquidity strategy with cash, bonds and borrowing capacity using a “three-tier” system. During a bear market, you can tap into each of these reservoirs in turn while waiting for a market recovery (at which time you can recharge the Liquidity strategy by tapping into the assets of the Longevity strategy):
Level I (common species) is reserved for current expenses over the next 6 to 12 months. These funds must remain in highly liquid solutions, such as cash.
Tier II (Cash Savings) are funds that are earmarked for other short-term expenditures, those planned for the next two years. For these funds, investors should consider basic savings, certificates of deposit or money market funds.
Level III (investment cash) are dedicated funds for medium-term spending, i.e. the remainder of the 3-5 year time horizon of your liquidity strategy. This part of your liquidity strategy is only meant to be operated in a bear market environment (in a bull market, the liquidity strategy should be used every year). Therefore, we recommend carefully managing the credit risk of these assets, as corporate bonds tend to be correlated to equities in volatile market environments. Tier III solutions include well-diversified fixed income portfolios, market-linked CDs, and CD ladders.
3. Realize capital losses
Over time, the investments in your taxable accounts will accrue significant capital gains. When you retire and start tapping into your portfolio growth to fund your expenses, it will likely trigger capital gains taxes.
Harvesting tax losses can help you reduce this tax burden and increase the potential after-tax return on your taxable assets.
Because markets tend to go up over time and losses tend to be short-lived, the best way to implement tax loss harvesting is to make small trades in your portfolio throughout the market. year as opportunities arise, rather than just looking to make a few deals. large transactions towards the end of the year.
To ensure that your portfolio does not stray too far from your target allocation, we recommend rebalancing your portfolio periodically using an allocation-based rule of thumb, for example, if your portfolio’s equity allocation diverges. deviates by more than 5% from your target (for example, above 65% or below 55% if your objective is 60%).
To implement rebalancing, you can reduce your allocation to assets that have exceeded their allocation and use the proceeds from the sale to buy more asset classes that have underperformed (and therefore declined as a share of the portfolio ).
If you have cash on hand, you can add to your portfolio as needed to bring the allocation back into range, allowing for “tax-free rebalancing” (because you won’t have to make any capital gains tax).
Rebalancing is not about whether markets will go up or down; rather, it is a strategy that helps you hedge against the risk that the markets do not continue in a linear fashion. Especially when market trends reverse, rebalancing can help improve your portfolio’s upside potential.
5. Accelerate planned Roth conversions
Roth IRAs are an attractive savings vehicle for retirement assets – they provide tax-free retirement income and are not subject to required minimum distributions over your lifetime.
Bear markets provide an opportunity to accelerate predicted Roth conversions for two reasons. The first is that all future gains will be fully exempt from income tax, instead of just tax deferral, as long as the assets have been in the Roth IRA for five years and you are at least 59 years old and half at the time of the Withdrawal.
Another benefit of making Roth conversions during a bear market is that it can help reduce the tax cost. The reduced tax cost can be especially high if you have both tax-deferred and after-tax dollars in your traditional IRA.
Since the tax liability is based on the taxable portion of your traditional IRA balance, i.e. the amount above any non-deductible (after-tax) contribution, a change in market value does not change the amount of your after-tax contributions.
Accordingly, a market downturn will reduce the portion of the Roth conversion that is subject to tax.
Read the full report Modern Monthly Retirement: What Retirees Can Do During a Market Downturn May 27, 2022.
Main contributors: Ainsley Carbone, Justin Waring and Daniel J. Scansaroli
This content is a product of the Chief Investment Office of UBS.
UBS Wealth Way is an approach integrating Liquidity. Longevity. Legacy. strategies that UBS Financial Services Inc. and our financial advisors can use to help clients explore and pursue their wealth management needs and goals over different time periods. This approach is not a promise or guarantee that wealth, or financial results, can or will be achieved. All investments involve the risk of loss, including the risk of loss of the entire investment. Deadlines may vary. Strategies are subject to each client’s goals, objectives and relevance.