Retirement savers are often told they’ll see a greater return in their retirement assets if they invest it – and that may be true – but it’s important to prioritize some cash in a retirement plan as well.
Retirement Tip of the Week: For those close to retirement, consider keeping a portion of your retirement plan in cash – whether that be in the portfolio itself, or in a separate account.
Bank and money market accounts do not generate the same type of returns as investments, though right now with volatility some investors may beg to differ. Investing in equities is an important factor in the puzzle for retirement income, as stocks and equity funds can create a larger return over time, but there are instances – like right now – when retirees could really use easily accessible cash.
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As the saying goes, “cash is king.” That’s not always true when it comes to preparing for retirement, but having cash on hand does allow retirees the opportunity to avoid tapping into their portfolio during market volatility. Retirement savers may be stressed to see their balances dropping week after week as major indices and sectors across the board suffer from the current volatility.
Taking money out of an investment portfolio when it’s on the decline can provoke the “sequence of returns risk,” which is when investors might suffer from lower possible returns over time because they tapped into their investments during a downturn. People who have to take from their retirement portfolios should do so conservatively, but if they can avoid it altogether, they’re giving their investments time to rebound when volatility subsides. Cash helps with that.
Cash can also be built into an investment portfolio, which is a strategy some advisers use for their clients especially later in life. Investors who have not yet dipped into their retirement plans, such as a 401(k) or IRA, may be forced to withdraw a portion of their portfolio because of required minimum distributions, which begin at age 72. Advisers may set aside a few years’ worth of required minimum distributions so that if there is market volatility, as is currently the case, the investments themselves remain untouched.
Investors may want to try the bucket approach, which is when investments are divided by time or goal segments. For example, three buckets could be divided into short-term (say five to 10 years), long-term (perhaps 25 years and beyond) and a bucket in the middle, between 10 and 25 years. The short-term bucket would be invested conservatively, such as cash investments, while the long-term would be invested more aggressively to generate returns over that time horizon.
There’s no one set amount of money that should be kept in cash – the answer depends on individuals’ personal circumstances and comfort level. One rule of thumb is to keep about a year or two’s worth of living expenses in cash however, which would be drawn down when portfolios are riding the rollercoaster of the markets.