My wife and I are in our late 50’s. We cannot emotionally tolerate a decline in the value of our retirement portfolio similar to what we experienced in 2008 and early 2009. Many baby boomers have similar feelings. Their response has been to leave the market entirely.
Pulling completely out of the stock market makes sense for that portion of your retirement nest egg that you are relying on to meet your basic retirement living expenses. Take care of those expenses first with one or more sources of guaranteed, inflation-adjusted income. We are doing that with a combination of Social Security, TIPS, and I-Bonds.
We also have other assets that can be risked in the market to potentially improve our retirement standard of living. But we want to manage our risk in case there is another severe bear market. Here are three steps that we have recently taken to limit our downside risk.
1. Replace mutual funds with equivalent exchange-traded funds. Many index mutual funds operated by large fund companies are now available as exchange traded funds (ETFs). ETFs trade like stocks. This means that they can be bought and sold quickly when the markets are open. Selling a mutual fund is a much slower process because the fund’s net asset value (NAV) must be calculated before the trade can be executed. Normally that happens at the end of the trading day. If the broad equity markets are falling rapidly during the day the values of your mutual funds are likely to experience the same decline before a sell order can be completed. It is much easier to control your losses during a sudden market decline with ETFs.
2. Place stop loss orders on ETFs. Now that we have our retirement money primarily in ETFs instead of mutual funds we can place stop loss orders on them. A stop loss order is a standing order with your broker to sell the security if the ETF price drops to a certain level or by a certain percentage. Thus, if the market is headed for a steep decline during the day (perhaps greater than 5 percent), we want to sell to limit our losses. The best way to do this is with a trailing stop loss order, in which the sell point constantly adjusts upward as the ETF value increases. If your broker doesn’t accept stop loss orders you can do the same thing by monitoring the prices of your retirement ETFs during the trading day or by setting up instant alerts of price declines on your holdings. If your sell price point is reached you will have to manually enter a sell order.
3. Consolidate ETF holdings. I am a couch potato investor in our long term retirement portfolio. When we moved from mutual funds to ETFs I reduced the different asset classes in our couch potato portfolio from ten to four. I did this to make things simpler. Now I have to monitor and manage risk in only four ETFs instead of ten mutual funds. This consolidation also lowers our transaction costs. If there is a severe market decline that triggers the sale of all our retirement portfolio ETFs we are paying only four commissions instead of ten.
As you get closer to your target retirement age controlling risk is paramount. Make sure you have processes in place to protect what you have.
Mark Patterson is an engineer, patent attorney, baby boomer, and author of The Failsafe Retirement System. He blogs on matters of personal finance and retirement planning at Tough Money Love and Go To Retirement.