“Parachute planning utilizes other assets or income vehicles during poor market cycles to avoid withdrawing from underperforming assets.” – Jonathan “JT” Belnap, Financial Advisor with Treasure Valley Financial Planning
As the financial markets continue to experience more and more volatility, it is understandable that many investors – especially those of you who are retired or expect to soon be in retirement – are feeling fearful and uneasy. It seems throughout much of the duration of the Covid-19 pandemic, the stock market has been flashing more red than green.
If you are nearing or are already in retirement, the prospects of a value-added portfolio over the course of your working and retirement years may seem quite dim and even discouraging due to the unpredictability of the markets right now. After all, we are living longer than previous generations, and we look to retirement as a time for indulging in leisure activities, traveling to our heart’s content, and enjoying spending more time with friends and family. All of these pursuits will require sufficient funds to draw from in order to have a comfortable, enjoyable, and fulfilling retirement.
The current market downturn is especially stressful for retirees who have their retirement funds allocated in stocks and bonds. Wild swings in the stock market could lead many investors to make major changes to their portfolio.
If you are like many other investors, there is a good chance that you have thought about substantially drawing down on your investments as retirement approaches. You may already be in retirement and find yourself highly anxious about whether you will have enough funds to pay for your various pursuits during your golden years.
This reactionary mentality of withdrawing large amounts of cash from your investments, an action that is typically driven by fear and uncertainty, can lead to poor decision making that could have serious consequences for the health and long-term viability of your portfolio.
“The vacillation excitement and panic – that is what hurts people financially,” says financial psychologist Dr. Brad Klontz, associate professor of practice in financial psychology and behavior finance at Creighton University Heider College of Business.
Dr. Klontz added that it is normal for people to feel panicked during times of major upheaval in the stock market. “It’s the way the human brain is programmed, with our emotional brains bigger and more powerful than our rational brains,” he explained.
Importance of Not Drawing Down from Your Investments
It is especially crucial that during a down market, characterized by strong volatility, that you avoid making significant withdrawals from your investments. You may think that pulling out large sums of cash from your equities is necessary to thrive or even survive your retirement years, i.e. having enough money to pay for travel costs, medical bills, and your favorite activities, or even allow you to cover basic monthly expenses or the cost of food. However, you might be making a grave mistake that could upend the value of your portfolio in the long term.
One serious consequence of an aggressive draw-down of your investments during a down-market is what is known as compound interest in reverse. It is also referred to as a sequence of return risk.
“A market cycle like we have been experiencing recently presents this risk,” says Jonathan “JT” Belnap, Financial Advisor with Treasure Valley Financial Planning. “If we are making withdrawals on our nest egg and at the same time experiencing underperformance in our accounts, we are subjecting ourselves to the sequence of return risk.”
A sequence of return risk poses a serious threat to an investor’s portfolio in that they could experience a sequence of negative returns in their investment portfolio early on in their retirement years. This, combined with withdrawals on the investment accounts, could deplete the investment account much sooner than anticipated.
Treasure Valley Financial Planning offers Parachute Strategy as Tool to Preserve Retirement Funds During Periods of Market Volatility
What Parachute Planning does is utilize your other assets or income vehicles during down market cycles so you, the investor, are less inclined to withdraw from underperforming assets, according to Belnap. Standard “parachutes” that Treasure Valley Financial Planning may advise their clients to deploy can include cash reserves, social security income, pension income, home equity lines of credit, and reverse mortgage loans.
Some of these strategies are designed to be temporary until the markets recover their losses, while for others, once deployed, they become permanent fixtures in the retirement planning strategy, according to Belnap.
How Cash Reserves Fit in with a Parachute Strategy
Belnap presents cash reserves as a simple but compelling parachute strategy that is based on the premise that you may not know what the market conditions will be when you approach retirement. Belnap advises, “We recommend reserving two to three years’ worth of retirement income in cash for this risk.”
By living on cash during the initial few years of retirement, a retiree will enjoy supplemental benefits that include low tax rates. This might provide a retiree with more useful strategic opportunities, as well.
One example of a strategic opportunity that an investor could avail themselves of is preventing a sequence of return from occurring because, by living off cash for the first couple of years of retirement, this eliminates withdrawals on investment portfolios when the markets are potentially underperforming.
Also, this helps to keep tax rates down, and that affords people opportunities to think about smart tax strategies like Roth IRA conversions. It also gives an investor peace of mind that regardless of market conditions, an individual can enter their initial years of retirement with greater confidence when it comes to preserving their retirement funds.
Finally, another strategic opportunity involves enabling people to postpone receiving their Social Security benefits or pension plans and allow them to potentially increase in value over time. This helps to ensure that more money will be available to a retiree in the later retirement years.
Including Social Security with Parachute Planning
While optimizing Social Security benefits has been trendy in recent years, one straightforward strategy that is usually overlooked is postponing Social Security income payments if the markets are favorable. Instead, it is better to begin to collect on Social Security benefits in an underperforming cycle.
Other important and relevant factors to consider when it comes to the timing of taking Social Security monies are your health and expected longevity.
Receiving Social Security benefits enables you to decrease or eliminate withdrawals on your investment accounts.
Other Income Sources Useful for Parachute Planning
Among the additional income sources that could pertain to parachute planning are annuity payments and pension plans.
“Reviewing those plans to see if it makes sense to turn on additional income and reduce or eliminate withdrawals on the investments is the name of the game,” Belnap explains.
It is worth noting that, unlike with cash reserves – which could be a temporary solution – an annuity payment or a pension plan may be an irreversible decision. That is why advisors at Treasure Valley Financial Planning recommend their clients fully comprehend all of these strategies’ options prior to deploying them.
Utilizing Reverse Mortgages and Home Equity Lines of Credit for a Parachute Strategy
According to Belnap, too many people approaching or in retirement don’t realize that their paid-for home is a retirement asset. There are many benefits wrapped up in the equity that is accruing in a home.
Tapping into this accumulating equity in one’s home is especially timely now during this period of market volatility and increasing inflation that has pinched the wallets of millions of Americans. The good news, however, is that home values have been growing at an exponential rate over the past couple of years.
Belnap points out how some clients at Treasure Valley Financial Planning have needed to do home repairs. But instead of withdrawing from their investment accounts in a down cycle, they are advised to consider a home equity line of credit to ‘float’ the expense for a short period of time until the market recovers. They then have the option of paying it back later.
As for reverse mortgages, they can be a very attractive option for retirees. When it comes to reverse mortgages, there have been a lot of misconceptions circulating in the media that have prompted unwarranted skepticism and doubt among homeowners. It is worth noting, however, that reverse mortgages are complicated products. That is why clients need to think carefully to ensure this is the appropriate solution for their specific financial situation.
The good news with a reverse mortgage is that it can also provide retirees with access to equity in their home or income payments that can help to reduce or eliminate investment withdrawals during a down market.
Look into a Parachute Strategy with Treasure Valley Financial Planning
“Clients are responding very well to the idea of creativity in a poor market cycle,” Belnap says. “No one likes to experience down markets, but if we can look at ways to improve our situation, it can make it more tolerable.”
Belnap encourages investors interested in the idea of parachute planning to contact his Treasure Valley Financial Planning firm. Whether you are nearing retirement or are already enjoying retirement, a parachute strategy holds much promise in helping investors successfully navigate the downturns in the markets, as well as market volatility, while preserving their retirement savings.