If you’ve invested for any length of time, you have learned that the stock market can be quite volatile, rising or falling several percentage points in a single day based on the day’s headlines, recent earnings reports, or seemingly at times for no specific reason at all. In fact, the S&P 500 historically has averaged one 10% “correction” (from market peak to bottom) approximately every 18-19 months and one or more 5% drawdowns in any given 12-month period. That volatility can be a good thing for those accumulating wealth as it can lower the average price of the investments you are buying when making regular systematic purchases (dollar cost averaging) into retirement plans or other investment accounts. However, the volatility can be unsettling and even downright scary for those who are currently in retirement and utilizing the nest egg that they’ve accumulated over decades to fund their income needs and replace former pay checks.
This market volatility is one of the reasons why it’s important for those taking income to have a structured plan in place to provide their income. You don’t want to be forced to sell some of the stock holdings in your portfolio when they are down 10% or more in order to fund your income need. Since its founding in 1978, CJM has a long history of providing clients with retirement income. This history spans many market cycles and we have learned some important lessons over those years. We established a system that gives clients peace of mind and we review it each year with each of our retirement income clients at our annual review meeting. For our clients who currently utilize their portfolios to provide them with retirement income or other needs, we aim to keep at least 3 years’ worth of their need in bonds and cash, which have been the historically safer asset classes in the portfolio. Bonds often act as a ballast in the portfolio, providing relative stability and holding their value when the stock market drops and investors get frightened causing a flight to safety. The cash will continue to hold its value regardless of what’s happening in markets although it’s value slowly erodes over time due to inflation. Keeping a portion of our retirement income clients’ planned income in these historically safer asset classes allows us to remain level headed and focus on long-term investment and planning objectives.
Our income funding plan, the three-year buffer, allows the stock portion of the portfolio time to rebound after a downturn before we may need to sell any of it to provide income needs. Since 1946, the average time to recover from a 10%-20% downturn in the S&P 500 has been about 4 months. As we know, larger downturns occur as well. When the S&P 500 has been down 20%-40%, the average time to recover has been about 14 months (source: CNBC). This means that holding at least 3 years’ worth of income needs in cash and bonds should normally be sufficient time for stocks to recover before we would have to consider selling them for income. Additionally, our 3-year target doesn’t factor in potential dividend or income payments from the stocks and bonds which would increase that time frame even a little bit further.
We know markets will continue to be volatile. Our three-year income plan helps reduce the heightened anxiety and stress during those difficult times as we know that there will normally be ample time for the portfolio to recover before the possibility of having to sell any of the stocks to provide income arises. This allows us to continue to focus on the long-term plan. Market turbulence, while natural, is unsettling. Knowing there is a plan in place to provide your income while also allowing the portfolio time to recover any potential losses can help make the market swings more tolerable.