Tese days, it takes a lot of courage to invest in stocks. Even though you may be convinced it makes sense to do so, you’re worried about having to sell in a down market.
Think about it this way: You’ll invest for growth through a balance of stocks and fixed-income investments. You’ll make yearly withdrawals from your entire portfolio—a certain percentage from your overall holdings—rather than simply scooping up any interest and income.
You’ll harvest the low-hanging fruit first, like stock dividends and income from treasuries or other bonds. This allows you to avoid transaction fees and taxes for selling off assets.
After the easy money is gone, you might need to liquidate some stocks as well.
This “total return” approach doesn’t require you to invest without a seat belt. During turbulent times, you’ll need a cash cushion.
In retirement, you should set aside enough of a cash reserve to provide for your living expenses for at least two years.
So how would this work? Let’s say you have committed to a portfolio of 60 percent stocks and 40 percent bonds (which may be too aggressive for many retirees). When you add a 10 percent cash allocation, the percentage of your stock and bond holdings in your total portfolio would drop to 55 percent and 35 percent, respectively.
You can keep that cash in a short term, FDIC-insured savings account or a money market account with a major fund family like Vanguard, Fidelity, or Charles Schwab.
Every month you’d write a check from one of these accounts and deposit the cash into your checking account. In a sense, you’re generating a monthly paycheck.
Then it won’t be as worrisome when the S&P 500 Index, or any other market benchmark, is experiencing a decline.
Once your cash dips below the one-year level, you’ll replenish the account by selling some of your holdings. But what if stocks are getting pummeled during that period?
As an interim measure, don’t touch the stocks. Instead, draw down your bond holdings—which should be composed of high-quality short- and intermediate-term bonds. The bond funds in my recommended portfolios fit into these categories.
Don’t forget to rebalance your holdings periodically. You want to keep your basic asset allocation intact. By asset allocation I am referring to the division of your investment portfolio between stocks and bonds.
Ultimately this should give you at least several years before you’d have to touch any stocks. This strategy makes it unlikely that you would have to sell equities at fire-sale prices during a bear market.
What’s the Point?
A two-year cash cushion and a well-balanced portfolio can help reduce your portfolio’s volatility and give you the courage to invest in stocks.