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Protect from ‘sequence of returns risk’
Stock market dips can be most harmful to portfolios during the first five years of retirement, which is the “danger zone,” according to Arnott.
If you withdraw money when asset values have fallen, there are fewer funds available to capture growth when the market rebounds, she said.
The phenomenon of poorly timed withdrawals paired with stock market losses is known as “sequence of returns risk,” and it could boost your chances of outliving retirement savings, Arnott said.
Negative returns cause more damage to portfolios early in retirement than later, according to a 2024 report from Fidelity Investments.
However, if you don’t tap your nest egg when the market is down, “you’re clearly going to change the dynamics, and you have a better chance of recovering,” said David Peterson, head of advanced wealth solutions at Fidelity.
The ‘cash bucket’ can shield your portfolio
Judy Brown, a certified financial planner, said the bucketing approach keeps clients “in their seat during market volatility” and offers the chance to discuss goals. Brown, who is also a certified public accountant, works at C&H Group in the Washington, D.C. and Baltimore area.
The bucket strategy divides a portfolio into short-, medium- and long-term spending goals, which requires maintenance from year to year to ensure the strategy remains effective and aligned with changing financial needs.
Typically, the first bucket should be “highly liquid,” like cash, and include one to two years of living expenses after subtracting guaranteed yearly income, such as Social Security or pension payments, recommends Christine Benz, director of personal finance and retirement planning for Morningstar.
“If you’re always spending from a cash bucket, then you don’t have to worry as much about making withdrawals when the market is down,” Arnott said.
The second bucket, which covers the next five years of spending, could be in short- to intermediate-term bonds or bond funds, and income distributions can replenish spending from the cash bucket, she said.
After that, you’re investing long-term in the third bucket, focused on growth with primarily stock allocations, depending on risk tolerance and goals.
