5 Ways to Help Weather Market Volatility

Learn How to Manage Retirement Assets During Difficult Times

 

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Market volatility is a term used to describe the daily fluctuation of stock and bond prices. How you prepare for and react to volatility can impact the value of your retirement portfolio and pre-retirement assets.

When investing for a long-term goal (like retirement many years ahead) it's generally easier to weather volatility simply because you have more time to recover from potential losses. But for those close to retiring and retirees relying on investment dollars as income, market volatility is an ever-present threat. Without proper planning, retirees run the risk of drawing on more of their principal balance earlier than they would like, or taking more risk with capital they'll need later in retirement in an effort to recover from losses.

With volatility virtually unavoidable for the long-term investor, and with near-term retirees being especially vulnerable to its effects, it is important to confirm that your retirement plans are structured to help mitigate the risks wherever possible.

Consider the following five ways to help weather volatility:

1. Maintain an Appropriate Asset Allocation

The heart of investing

Investing across a thorough mix of assets — diversification — can help to reduce the effects of volatility on a portfolio.

Need convincing? Since 1926, 28% of stock market and 8% of bond market returns were negative on an annual basis. However, only about 2% of the time did both stocks and bonds post simultaneous negative returns. Managing your stock/bond allocation can have a significant impact on the stability and predictability of your portfolio's performance.[1]

Beyond stocks, bonds and cash, other asset classes to consider for diversification include real estate and alternative investments, like hedge funds and private equity funds, and even metals and collectibles (for qualified investors and depending on account type).

That’s not all. Look inside each asset class, too. If you’re investing in stocks, you could allocate a certain amount to large-cap stocks and a different percentage to stocks of smaller companies. Or you might allocate based on geography, putting some money in U.S. stocks and some in foreign stocks. Bonds might be allocated by various maturities, with some maturing quickly and others later. Or you might favor tax-free bonds over taxable, depending on your tax status and the type of account in which the bonds are held.

There is a behavioral perspective here, as well, according to PNC’s Chief Investment Strategist Bill Stone. He suggests that employing an appropriate, long-term asset allocation strategy to match your retirement objectives, time horizon and risk tolerance level may help to alleviate the dangers of becoming distracted from your long-term focus by bouts of volatility. Put simply, if you know your strategy was created for the long-term and you recognize that volatility is bound to occur along the way, you may be able to avoid the impulse to make a suboptimal, reactionary financial decision.

Watch Now: Understanding Asset Allocation

 

2. Don’t Just “Set It and Forget It”; Re-Evaluate Your Portfolio Periodically

The benefits of systematic rebalancing

Once your asset allocation is in place, it is important to re-evaluate from time-to-time (Stone suggests at least annually) to account for any changes in circumstances and to systematically address changing market conditions. Over time, changes in market prices can cause a portfolio's asset mix to veer off course. For example, a robust stock market, while beneficial to growth, can tilt a portfolio heavier toward stocks.

Rebalancing your portfolio on a regular basis offers a number of additional benefits, including providing you an opportunity to keep your portfolio aligned with your personal tolerance for risk, and potentially improving its market value by pushing you to buy low and sell high.

Here’s an example of how rebalancing makes a difference:

Benefits of Rebalancing (Without Withdrawals)

One investor rebalanced this portfolio back to target annually, and one investor made no changes during the time period. The simple, systematic strategy outperformed the do-nothing strategy.

Source: Bloomberg L.P. and PNC. Asset allocation target of 65% stocks and 35% bonds.

A more optimized rebalancing strategy could produce even better results, but the idea here is that even a very simple plan may improve results over time.

 

3. Build a Cash Cushion

The best offense is a strong defense

In periods of volatility during retirement, the best offense is a strong defense. If you’re no longer working and unable to add to your retirement fund to recoup losses like you would during career years, it may be a good idea to build a cash cushion or income shield — about one-to-two years’ worth of expenses, Stone says.

Cash here refers to any safe, near-liquid investment. While these investments provide only modest returns even in the best of times and near zero returns in the current environment, the stability they provide acts as a type of insurance against becoming a forced seller. Nothing is more harmful to an investor than having to sell during a down market.

A liquidation plan requires some thinking, Stone cautions. You might think you’re being vigilant in padding your annual withdrawal figure to prevent a cash shortage, but the reverse actually proves beneficial in that withdrawing less means you’re sustaining portfolio market values. Keeping withdrawal assumptions conservative helps to keep more of your portfolio invested. The key would be to maintain normal allocations with the money earmarked for use over longer investment holding periods. Of course, you can always readjust as you go.

 

4. Establish an Income Floor

Preserve capital for peace of mind

Retirees dependent upon monthly income streams may find an “income floor” investment approach reassuring. This method can bring peace of mind while the market fluctuates, because the portfolio is structured to yield enough income to cover basic needs.

Beyond that, the remainder of the portfolio is aimed at preserving capital, managing risks and warding off inflation. With more and more retirees living longer into retirement, preservation of capital is increasingly important. (Consider that you may need to fund a retirement that lasts 20, 25 or even 30 years!)

Start by thoroughly and honestly assessing your annual income requirements during retirement. PNC’s Retirement Lifestyle Planner can help you to consider all of the choices and factors impacting the amount you think you’ll need to cover expenses each year. For some, Social Security and pensions may be sufficient for basic expenses, and this is the theoretical “floor.” Others may supplement those income sources with dividends and interest from investments, and will need to determine how much is needed in regular distributions to meet expenses.

Income from bonds or bond funds can provide for predictable, stable cash generation. A bond ladder, or portfolio of bonds with different maturities matching each year of retirement, is another method that aims to meet cash needs. Consider keeping some exposure to assets (such as stocks) that have historically grown purchasing power over time, too — to help provide some protection from inflation.

 

5. Stay Invested (and Don’t Panic-Sell)

It’s generally best to ride it out

As you near or enter retirement, your investment time horizon will quickly disappear, and so will your tolerance for risk. At the same time, the realization that your assets need to last the duration of your retirement will kick in. You may be tempted to take on riskier investments to potentially achieve higher returns — but it is important not to make impulsive decisions.

One of the best ways to achieve your retirement investing goals is to carefully create a long-term financial strategy and not sway from it, even when market conditions are less than ideal.

The power of staying invested is clear. For a 20-year period ending in 2015, the market experienced an average annualized total return of 8.2%. A $10,000 initial investment — assuming you stayed fully invested for the duration — would have grown to $32,839, not including the reinvestment of dividends (which would bring that figure closer to $50,000). Using the price appreciation only, if you pulled money out during that 20-year period for whatever reason, you’d be significantly worse off — because it can be hard to catch the upturn in the market. For example:

  • Missing the 10 best days, balance would be worth $16,401 ($16,438 less)
  • Missing the 20 best days, balance would be worth $10,225 ($22,614 less)

The short answer is this: When volatility strikes, it’s generally best to stay invested and ride it out.

 


PNC Chief Investment Strategist, Bill Stone
Mr. Stone leads PNC’s investment strategy team of analysts monitoring factors that influence the direction of domestic and international financial markets.

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    1. Historical Returns and Range of Returns by Asset Allocation Profile, 1926-2015, Ibbotson Associates and PNC.

    This material is meant to educate and not to provide legal, tax, accounting or investment advice. PNC Investments and its affiliates and vendors do not provide legal, tax or accounting advice.

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