What to Do If Your Retirement Account Takes a Hit
The great recession wiped out billions of dollars in retirement savings. Even though the stock market has recovered since then, global economic woes and international strife continue to create volatility in the markets. Take China, for example. A slowdown in growth in that country has sent Chinese stock market plummeting and pulled down stocks in other markets as well. No doubt, these losses have affected the retirement accounts of people far from China.
Investment losses at any age are hard to stomach, but for people nearing retirement or already out of the workforce, big losses in retirement accounts can lead to fear, panic and dread. After all, if you only have a few years until retirement, you may not have the luxury of recouping losses by waiting for the next market cycle. And if you are already retired, a loss in your account means less income and can force lifestyle changes like cutting back on expenses, taking in roommates or moving in with a relative.
You can try to prepare your retirement for times like this by using a bucket strategy, notes Michael Mezheritskiy, president of Milestone Asset Management Group in Avon, Conn.: "Allocate the portfolio into three categories: cash, income producing fixed income, and a growth portfolio. Depending on the client's particular risk tolerance, we typically end up with about two years of needed income in cash, five to seven years in fixed income, and the rest in a diversified portfolio.The idea is that, if there is a market pullback, you have about seven to nine years of income in a conservative allocation, giving your portfolio an opportunity to come back"
But even the best-allocated portfolio will get at least somewhat battered in bad times. While nobody wants to lose money in the stock market, there are smart ways to react when it does happen. From maintaining a long-term view to increasing the amount of savings, here’s what to do when your retirement account takes a big hit.
Reign in the Desire to Get out of Stocks Altogether
Fear and greed are two elements of human nature that are among the hardest to control. When your retirement account is beset by loss after loss, a natural reaction is to cash out and hide your money under the mattress for safekeeping. But that’s one of the worst things you can do.
If you act out of fear, you will probably sell stock at a low price and miss the likelihood of the stock recovering. Focus on mitigating further losses while also keeping an eye on the long term. Retirement can easily last more than 20 years, and you need your money to grow. This means that some of it must be invested in stocks. Keeping your money in savings account or CD may protect your dollars from a market crash, but over time those dollars will be worth less and less thanks to inflation. (Read more in How to Avoid Emotional Investing.)
For investors who face losses when they have years until retirement, reacting by cashing out of the market should be far less of a temptation. As long as the asset allocation remains in line with your retirement plan, short-term drops in value aren’t something to lose sleep over. History has shown that stocks that tank often recoup their losses in a relatively short period of time.
"First, it is important to never put yourself in the position of taking a hit to your retirement nest egg if you are close to retirement. However, if it does happen, you should stick to your investment plan," says Kirk Chisholm, wealth manager at Innovative Advisory Group in Lexington, Mass. "If your plan is to sell if your investment drops more than 20%, then you should do it. If your plan is to never sell no matter what, then you should follow the plan. Too many investors find it difficult to deal with loss in their investments. Don’t sell because of fear, sell because it is part of your plan. If you don’t have a plan, then you need to get one."
Delay Retiring or Get a Part-Time Job
For those very close to retirement, a loss in the retirement account is a different kind of challenge. On the one hand, they want to have enough money to live off without having to downsize their lifestyle when they enter retirement. On the other hand, waiting to reach that sum may mean giving up their dream of retiring at a certain age. (Read more in What Retirement Will Look Like Without Savings.)
Faced with losses in a retirement account, people have to choose between living off less money or extending their retirement date. Since having enough money to retire on is the end goal, it's better to delay retirement. After all, the longer you are employed, the more time you will have to save money. Compounding will boost your returns and further increase your retirement income.
If you have already exited the workforce and see big losses in your retirement account, consider taking a part-time job to increase your savings and, at the same time, supplement your income. It may not be the ideal situation, but it’s better than selling your home or overhauling your lifestyle drastically to make up for the shortfall.
Tap Other Sources of Income
If delaying retirement or getting a part-time job is not an option, you should still resist the temptation to sell stocks and other investments to free up cash. Instead try to live off your savings account, CDs, bond interest or other income from your investments. The idea is to give the stocks in your investment portfolio time to recoup their losses and, one hopes, appreciate more before you start using them to live on.
"It is essential that retirees and pre-retirees have a cash reserve and a portion of their investments in high quality bonds," says Damon Gonzalez, CFP, RICP, of Domestique Capital LLC in Plano, Texas. "I am not talking about corporate or high-yield bond funds. You want bonds that are likely to go up during a stock market selloff."
If you can’t handle the losses on paper, scale back your exposure to stocks and increase your holdings in bonds – but try to stay invested in equities. "Your bonds may not make you that much money over the long haul," Gonzalez says, "but they are designed to be an anchor for your portfolio, to provide a place to pull money from when stocks are down, and to help you stick with your strategy when it doesn’t appear to be working." Stock market declines don’t last forever, but your retirement can go on for a very long time.
The Bottom Line
Losing money in a retirement account at any age can be heart wrenching, but for people nearing retirement or already out of the workforce, big stock market losses can be life changing. Resist the urge to pull money out of the market. Give your account a chance to recover by delaying retirement or getting a part-time job. For the best chance at recouping losses, retirees should always stay the course on their investment plans.