4 ways to protect your retirement income when markets are volatile
If you’re worried about stock market volatility and how to protect your retirement savings so it lasts for the rest of your potentially long life, I have some advice for you: Don’t spend your retirement savings!
Instead, use your savings to set up “retirement income generators,” or RIGs for short, to generate regular lifetime income that lasts the rest of your life. Then, in any given month, don’t ever spend more than the total amount of your retirement income. This way, you won’t outlive your savings. Also, be sure to set up your RIGs so they withstand the stock market crashes that are inevitable if you live a few more decades.
The good news is, figuring out how to generate a regular lifetime paycheck from your retirement savings doesn’t need to be hard. There are basically just four strategies to do it, and each method contains a way to protect yourself from stock market volatility.
RIG #1: Social Security bridge payment
Social Security provides the most risk-protection of any retirement income generator. It protects you against:
- Longevity risk, the risk of living a long time
- Stock market risk, since your income doesn’t decline when the stock market crashes
- Inflation risk, since your benefits receive a cost-of-living adjustment each year
- Mistakes, fraud, and cognitive decline, since your income is paid automatically each month
You can maximize the income you’ll receive from Social Security through a thoughtful strategy to delay the start of your benefits, often to age 70 for most people. The best way to delay starting your Social Security benefits is to work just enough to earn the amount you would have received if you’d started Social Security when you retired.
However, if you don’t want to continue working or you can’t keep working, the second-best way to delay Social Security benefits is to use your savings to fund a Social Security bridge payment. To do this, on a monthly basis, you’d withdraw from your savings the amount of Social Security income you would have received if you’d started Social Security when you retired. Continue making these monthly withdrawals until you start your actual Social Security benefits. For most people, a Social Security bridge payment will generate more additional retirement income than other RIGs described below.
Use the bridge payment, and eventually your Social Security benefits, to help cover the cost of your “needs”—your basic living expenses.
RIG #2: Annuity
Use a portion of your savings to buy a cost-effective annuity from an insurance company that will guarantee to pay you a monthly income for the rest of your life. You can use the annuity to supplement your Social Security bridge payment or benefits to cover the cost of your basic living expenses.
When it comes to annuities, you have options. For example, you can buy an immediate annuity that’s fixed in dollar amounts, one that’s adjusted for inflation, or a variable annuity that’s adjusted according to an underlying portfolio of stocks and bonds. You can also buy an annuity that starts at a later age, or you can purchase a hybrid annuity that includes some of the features of systematic withdrawals (see RIG #4 below).
RIG #3: Investment income
Invest your savings—either all or in part—and spend just the investment earnings, which are typically interest and dividends. You can invest in a variety of mutual funds, bank accounts, individual stocks and bonds, real estate investment trusts, or rental real estate. Don’t touch the principal.
For the part of your savings that are invested in the stock market, the volatility in the amount of the dividends you receive will usually be much less than the volatility in the value of your underlying investments. This means that during a stock market crash, the amount of your dividend checks will decrease less than the value of your investments. This provides some protection against stock market crashes.
Use this income to cover the cost of your “wants”—entertainment, travel, and gifts. Hopefully you can reduce these expenses if the amount of your investment income decreases due to a stock market crash.
RIG #4: Systematic withdrawals
To help cover your “wants,” invest your savings—either all or in part—and draw down the principal and investment income cautiously, using a method that’s designed to generate income for the rest of your life.
With this method, you can invest your savings on your own and decide how much to draw down, or you can use a managed payout fund or service that does the investing and withdrawing for you.
To help make your retirement savings last during stock market crashes, adjust the amount of your withdrawal periodically to reflect recent investment experience. For example, if your investments have increased due to favorable performance, you can increase your withdrawals. On the other hand, if you’ve experienced investment losses, you should probably decrease your withdrawals. One way to make these adjustments is to apply a withdrawal percentage to the value of your investments at the beginning of each year to determine your monthly withdrawal amount.
Built to last
Each type of RIG described above will generate different amounts of retirement income. As a result, it’s important to remember that you don’t need to use just one type of RIG to generate the income you need. In fact, it might be best to use a combination of a few different types to spread your risk around and best meet your financial needs. In addition, there can be good reasons to change your RIGs as you get older.
If you expect your retirement to last 30 years or more, it’s an essential part of your retirement homework to learn more about the different RIGs and the amounts of retirement income they can generate. It’ll be time well spent, and it will help you relax during trying times such as these, when the stock market is gyrating wildly every day.