Buzz
The stock market can be unpredictable, yet many people keep their retirement funds exposed to its fluctuations. So, how should you react if a market crash happens just before your retirement date?
Despite what the media often suggests, those in this situation rarely "lose everything," unless they've invested in high-risk assets like penny stocks (as opposed to safer options like mutual funds and ETFs). The market is cyclical, and major crashes tend to happen every decade or so. It's impossible to predict exactly when these crashes will occur, and each one brings a wave of fear and anxiety.
In most cases, the best approach during a crash is to simply hold on. If possible, consider purchasing more shares while prices are lower. However, when you're on the verge of retirement and see your savings significantly reduced, that plan becomes much more daunting.
Stick to Your Plan
In truth, your situation when nearing retirement is not much different from someone younger, who has the advantage of enduring the market downturn.
If this seems unexpected, it’s because of a common, though often unspoken, belief that your retirement savings stop growing the moment you retire. Many people, without realizing it, think that if the market crashes just months before their retirement, they're doomed, because they no longer have the luxury of letting their investments recover like younger individuals.
That assumption is incorrect, as it ignores two crucial points:
For most people, you'll likely live for another twenty years or more after retirement, giving you plenty of time to weather not just one, but several market crashes.
What matters most in retirement is not the total value of your investments, but the consistent income it provides you.
So, while it may be more difficult to endure a market crash, try not to let it overly distress you.
Prioritize Income-Generating Investments
As you near retirement, it’s crucial to shift your focus from the lump sum of your nest egg to how you will rely on it for income.
Start by creating a monthly budget. In today's world, we live on a monthly financial cycle. Mortgage or car payments, utility bills, phone services, and even Social Security benefits are all paid on a monthly basis. That’s why it’s essential to determine how your retirement savings will cover these recurring expenses.
Next, convert your investments into those that provide a steady monthly or quarterly income. Even during a stock market crash, these types of investments will continue to deliver their regular payouts. Here are some options.
Bonds
As you age, it's wise to gradually shift your investments from stocks to bonds. By the time you retire, a significant portion of your savings will be in more stable assets. Most people invest in bonds via mutual funds or ETFs, as buying individual bonds directly is complicated. (Single bonds typically cost around $1,000 each, and transaction fees are high. To build a diversified bond portfolio, the investment amount required often exceeds what most individuals can afford.)
However, be mindful that when interest rates rise, the value of bond funds tends to decrease. While not as dramatic as a stock market crash, this drop can still be unsettling—so it's important to stay calm. If you focus on the regular income from bond funds and ignore their fluctuating value, stock market crashes will affect you much less.
Rental Properties
Purchasing the property next door to rent out can be a sound investment. Rent payments come in each month, regardless of the market’s performance, and most lease agreements include escalation clauses that increase rents over time.
However, there’s a risk that a recession—which typically follows a market crash—could cause tenants to delay or miss rent payments altogether. Additionally, to buy a rental property, you generally need a substantial amount of capital, usually $50,000 or more. If you finance part of your rental property investment with debt, you’re increasing your risk, as you’ll still owe payments if tenants can’t pay their rent during a downturn, or worse, fail to pay at all.
For the most part, rental income is largely unaffected by stock market fluctuations, and the effort involved can make it a worthwhile investment.
Annuities
Annuities are financial products offered by service companies. Typically, you purchase one with a lump sum, and in return, it provides you with regular monthly payments. Essentially, you receive back your initial investment along with interest or yield over a set number of months. These payments are mostly immune to economic conditions or stock market performance. Annuities are favored by individuals who prefer not to deal with investing, opting instead to have a professional manage it for them.
The key term here is "paid," because these professional investment managers don’t come cheap. Annuities are often sold by high-commission agents, similar to timeshare deals. The costs are paid upfront, and the real question is whether the returns from the professional managers outweigh the higher fees. Often, they don't. For someone who is extremely risk-averse and/or wants to avoid managing investments, annuities are a reasonable choice—much like hiring someone to clean your car or mow your lawn. It’s costly but preferable to doing nothing.
Dividend Stocks
If you'd rather not withdraw a lump sum from your investment portfolio for property or annuities, and you're concerned about rising interest rates impacting your bond funds, there's another investment avenue to explore: dividend stocks. As retirement approaches, you can replace your mutual funds, ETFs, and stocks with dividend-paying stocks.
There are two primary types of dividend-paying stocks to consider:
Dividend Aristocrats: This is a prestigious group of roughly 50 stocks that have consistently paid increasing dividends for 25 years or more. It’s crucial to understand two things about these stocks (which you can learn more about here):
These stocks have consistently paid dividends even through two or more market crashes and recessions.
Not only have they continued paying dividends, but to be included on this list, they had to increase their dividend every single year.
Dividend Aristocrat stocks provide flexibility in how you invest: you can choose to purchase individual stocks and build your own portfolio or invest in an ETF or index fund, which offers more diversification for a small fee.
When the stock market takes a downturn, the value of these stocks may drop as well. However, if you're holding them primarily for the dividends, this isn't a concern. These stocks are among the most reliable, and their prices will recover along with the market.
Preferred Stock: Another category of dividend-paying stocks is preferred stock. Some of these stocks offer higher dividends compared to others, but their dividends remain fixed. Others have variable dividend rates. Preferred stocks resemble bonds in that they pay quarterly dividends, yet they are much easier to purchase, as they trade like regular stocks, allowing you to buy as many or as few as you like. As with Dividend Aristocrats, you can invest in preferred stocks through ETFs or mutual funds.
As you near retirement, it's essential to adjust your retirement portfolio so it generates the monthly or quarterly income necessary for the lifestyle you've worked so hard to achieve.
If you're approaching retirement, now is the time to make these adjustments. With a portfolio of the investments mentioned above, you'll be well-equipped to weather the inevitable stock market crashes that will occur throughout your retirement.
Photo by Jim Vallee (Shutterstock).
