Retirement | November 5, 2021

Market Volatility in Retirement: What if You Haven’t Prepared?

A market downturn can pose a challenge to your finances in retirement—chiefly, the risk that you’ll have to sell investments at depressed prices to generate income. The problem here is twofold: When prices are low, you have to sell more assets to raise a set amount of cash, and tapping your portfolio in a bad market could permanently undermine your ability to participate in any future recoveries.

Ideally, retirees should aim to avoid this kind of crunch. We recommend keeping at least a year’s worth of money that you need from savings to support expenses in cash investments—such as checking or savings accounts, money market funds or certificates of deposit (CDs)—with another two to four years’ worth in relatively liquid, conservative investments such as short-term Treasuries and other high-quality bonds or short-term bond funds. A four-year cushion should help manage risk in most bear markets (according to research by the Schwab Center for Financial Research, from the 1960s through 2021, the average peak-to-peak recovery time for a diversified index of stocks in bear markets was about three and a half years1).

However, if you haven’t prepared, all is not lost. Consider the following steps to minimize the impact of a down market on your retirement portfolio:

Step 1: Know how much you can spend

If you haven’t done so already, you should figure out how much you can spend annually from your portfolio while maintaining a high degree of confidence that your money will last throughout a 30-year retirement. One common rule of thumb is for retirees to withdraw 4% of their portfolios in the first year of retirement and then adjust that amount for inflation every year thereafter.

While that’s fine as a general rule, you can get a more precise and dynamic calculation by creating a plan with a professional financial planner or using online tools. These can map your withdrawals and spending in various types of markets, using projections to estimate the probability of your savings going the distance. Market changes—both up and down—can affect those probabilities.

If the probability of your savings lasting is 80% to 90% or more, that’s good. However, if it drops below 75% or thereabouts, we suggest making small, temporary adjustments to keep your plan on track. For example, if you’re using the 4% strategy, ask yourself if you can skip an inflation adjustment this year, or make other small tweaks. If the likelihood is lower than 75%, we suggest considering more sizable adjustments in spending from the portfolio to allow time for markets to potentially rebound.

Step 2: Look for ways to reduce your spending

Start by drawing up a budget. It may help to group your expenses in terms of needs, wants, and wishes. Your needs are the essentials—think food, housing, health care, insurance, and taxes. Wants are the nice-to-haves like eating out, a gym membership, or travel. Wishes are the things you’d do if you had unlimited time and money.

Cutting back on wants and wishes is the place to start. For example, can you limit how often you eat out in restaurants, or choose less-expensive ones? Can you postpone buying a new car or taking a vacation trip?

Step 3: Look for other cash solutions

Do you have an emergency or rainy-day fund? Do you have any cash sitting around in an old, neglected account? This is the time to think about using them. If you’re expecting a tax refund, then you should think about filing right away. If you’re expecting a tax bill, consider saving for it now, rather than letting it sneak up on you come Tax Day.

You could also get creative. Do you have things you could consider selling? Also, see if a refund can be issued on any pre-paid annual subscriptions you might have. These are often harder to spot on a monthly budget.

Do you own an annuity that you purchased as an investment but haven’t “turned on” the income yet? Talk with a financial planner or annuity specialist about whether starting income now would make sense, so you don’t have to start drawing from your investment portfolio.

In short, every dollar you can access today from other sources is one you don’t have to pull out of your investment portfolio by selling more volatile assets.

Step 4: If you must tap your savings, be strategic.

  1. Start with interest and dividends from your taxable accounts. Leaving the original investment untouched means it can potentially continue to grow, and potentially yield more dividends and/or interest in the future. Interest is taxed as ordinary income—unless it’s from a tax-free municipal bond or municipal bond fund, in which case interest income is often exempt from federal and, potentially, state income taxes. Dividends, on the other hand, are often taxed at the lower capital gains rate of 0%, 15%, or 20%, depending on income level—provided certain requirements, such as minimum holding periods, are met.
  2. Tap the principal from maturing bonds or CDs. The principal from a maturing bond or CD in your taxable account is often the next place to turn—particularly if interest rates have declined and you won’t earn as much by reinvesting the proceeds. Generally speaking, you won’t owe any taxes on your original principal; an early sale may trigger capital gains taxes if you earn a profit on the sale.
  3. Consider selling lower-volatility investments. Next, consider selling lower-volatility assets, such as short-term bonds or bond funds, that haven’t been as buffeted by the recent market volatility.
  4. Rebalance your portfolio. If asset sales and the recent market turbulence have left your portfolio out of alignment with your long-term allocation, consider looking for opportunities to raise cash by rebalancing—that is, selling any assets that have risen in value and are now out of balance in your portfolio relative to your desired allocation and buying those that have decreased in value, in order to return your allocation to its original target. Start by determining how much cash you’d like to free up and subtract that from your current portfolio balance. Then use that new balance to determine your target dollar amounts for stocks, bonds, and cash investments, based on your target allocation percentages. That will tell you how much of each asset to buy or sell to both raise cash and rebalance your holdings.
  5. Prune unattractive investments. If you still need cash, focus on shedding assets whose prospects no longer match your goals. This kind of portfolio maintenance is a good idea in any market, but it can be particularly useful when you’re looking for items to sell. A rule of thumb is that if you wouldn’t buy more of a particular investment today, then you should consider selling it.
  6. Use investment losses to reduce your tax bill. Do you have any assets in taxable non-retirement accounts that have fallen in value? You can use those losses to offset gains you may have realized in your taxable accounts over the course of the year, which can help reduce your tax liability—a strategy known as tax-loss harvesting. Even if you have no gains to counteract, you can still use your losses to offset up to $3,000 of ordinary income per tax year until all your losses have been accounted for.
  7. Make tax-efficient choices. If, after harvesting all your losses, you still need to sell assets from taxable accounts to meet your cash needs, be sure to make tax-efficient choices. For example, consider selling investments you’ve held for more than a year. Any gains on stocks, bonds, and mutual funds held for more than one year are taxed at a maximum federal long-term capital gains rate of 20%, whereas investments held for a year or less are taxed at your federal ordinary income tax rate. Some gains may be subject to state and local taxes as well.

The bottom line

It’s impossible to say what the future holds, but anything you can do to lighten your reliance on large withdrawals from retirement savings during a downturn can help preserve your savings over the longer term. Even small reductions to withdrawals can go a long way toward giving your portfolio time to recover and helping your savings last.


1Schwab Center for Financial Research with data provided by Bloomberg. Research identifies periods in which the S&P 500 Index fell 20% or more over at least three months. Time to recovery is the length of time it took the S&P 500 to complete its peak-to-trough decline and then rise to its prior peak. Past performance does not guarantee future results.

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