Living on Retirement Savings? How to Prevent Panicking in a Crash

Last Updated Jun 28, 2010 4:05 PM EDT

Retirees who rely on their retirement savings for income are challenged when the stock market crashes, as we've seen with the recent crash. Many panicked and sold their retirement assets at a low, later regretting this decision when the stock market bounced back. But is it possible for you to invest your retirement savings to prevent panicking in a crash? You bet. Let me show you one way to do this.

I've seen a number of articles about a disciplined retirement investment strategy that helps you decide how much risk you can take in your retirement years and still ride out a stock market crash. These strategies go by various names, but they're most commonly called the "bucket approach" or "age-banding." For the purpose of this post, let's use the term age-banding.

Dr. Somnath Basu, director of the California Institute for Finance at California Lutheran University, recently wrote a paper that describes this approach, titled Age Banding: A Model for Planning Retirement Needs. His website, www.agebander.com, provides more details on the approach, along with software to help individuals and planners implement this strategy.

Let's look under the hood of this investing strategy to see how it might work for you. If you used this approach, you'd typically start by calculating the amount you would need to withdraw from your retirement investments for the first 10 years of your retirement. This is your first age band or bucket. For these amounts, you would use very conservative investments such as bonds, CDs, or conservatively invested mutual funds. This way, you can feel secure that if the stock market crashes again, you have the money available that you need for your retirement living expenses for the near future. And you won't need to sell your retirement investments during a market downturn.

Next, you would calculate the amount of your withdrawals for the second decade of your retirement. This is your second age band or bucket. For these assets, you would allocate more to stocks, ranging from one-fourth to one-third, since you have at least 10 years to ride out any stock market crashes. For assets that you won't use until the third decade of your retirement and beyond, you can invest substantial amounts in stocks, as much as two-thirds or more, since you'll have more than 20 years to ride out any market crashes. You'd want to account separately for the part of your retirement savings that are in each age band or bucket -- one way is to set up separate sub-accounts with your financial institution.

Common variations of this strategy might include more age bands or buckets that cover periods shorter than 10 years, or different asset allocations within the various bands.

In summary, the conservative investments in the first two age bands give you confidence that you'll meet your retirement living expenses in the near to intermediate future, while the stock investments in the third band give you growth potential to address the threat of inflation over the long run.

I like the underlying theory and goals of the age-banding approach, provided you're withdrawing principal in your retirement years. (See my prior post Make Your Money Last for Life for an overview of three different ways to withdraw from retirement savings, from living on investment income to buying an annuity.) But you may not need the age-banding approach if you decide to buy an immediate annuity or just live on investment earnings. For this reason, before investigating the age-banding approach, I'd recommend you first decide your overall approach to withdrawing from retirement savings. If you decide that withdrawing principal is appropriate for you, then you can investigate further the age-banding strategy to see if it's a good fit for you.

Some people may need help analyzing the amount and type of assets to allocate to each band, and for making the appropriate shifts from stocks to more conservative investments as you live and move through the age bands. For this reason, you may need to consult with an investment professional to effectively implement this strategy.

If you think you might need some professional help, be sure to select an advisor who is much younger than you. I'm not kidding. You might need this person for the next 20 years, and you want them to be around for a long time so you don't have to switch advisors mid-stream. You should also choose an advisor who understands and is enthusiastic about the age-banding approach.

No matter what this retirement investing strategy is called, it can be a powerful tool to help you manage and draw down your retirement savings. But as I always advocate, take the time to look carefully before you decide!

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.