Few experiences are more frustrating or frightening than facing retirement around the time the stock market crashes.
Even if you have done the financial planning, retirement planning, and have retirement savings, you will struggle with the question, "Should I even think about retiring during a stock market downturn?"
Rather than panic as you imagine your retirement income slipping away as stock prices plummet, pause and practice calm. Here are a few ways you can decide if you're ready to retire, even if you're facing a bear market or other uncertain economic conditions.
Step 1: Recognize the Stock Market Has Cycles, and We Will Recover
The first thing you can do is recognize the stock market has cycles of bull and bear markets. Market volatility is part of the risk you take when you start out with any investment strategy. Even if you have years with a bullish market, you should always be aware that the next bear market will happen eventually.
Since the late 1990s, investors have experienced the dot.com bust, the housing market collapse of 2008, and the current recession on the tail of the Covid Pandemic.
Market crashes, although disheartening, are part of the market cycle. Younger investors tend to panic when they lose money in their first few bear markets, but seasoned investors can take heart that market conditions tend to improve over the long term.
Even during a market downturn, you can recognize that your retirement accounts will improve when the stock market makes a recovery.
Step 2: Stress-Test Your Portfolio to Prepare for a Bear Market
Stress-testing your portfolio means looking at your investment portfolio in light of a worst-case scenario.
As an exercise, assume a 20% down market with no recovery. Then, look at your financial research and financial planning with that 20% loss as the norm. If your accounts all have 20% less and you still have enough money for financial security, then your retirement savings are solid.
If your retirement accounts can pass this risk tolerance test, then you are set for retiring even in a down market. Remember, in general, the stock market recovers quickly and losses are rarely permanent.
If your diversified portfolio passes this stress test, you are in pretty good shape. Congratulations!
However, if that theoretical 20% hit to your account value resulted in your withdrawal income being less than what you need to live on each year, you'll need to continue working with a financial professional to create a stronger nest egg. Continue on to step three.
Step 3: Audit Your Spending During a Down Market
During a bear market, take stock of your financial well-being. Do an audit of your personal finances and determine the difference between your essential and non-essential spending.
You always have some wiggle room in your budget.
It's likely you have required expenses, but you will always have non-essential spending built into your budget, either due to habit or desire.
If your financial research revealed that your portfolio didn't pass the market crash stress test, you could trim your current living expenses while simultaneously creating more long-term purchasing power by building up your retirement account.
You could also explore postponing large purchases. For example, wait to buy a new vehicle or take an expensive trip for just six months while you wait for the stock market to recover and stock prices to go back up.
Focusing primarily on essential spending and tweaking your personal finance strategy to exclude non-essential purchases during a bear market will help you with asset allocation. You can then build a stronger, more balanced portfolio for that long-term nest egg.
Step 4: Use Your Emergency Fund Cash Reserves in Case of a Stock Market Decline
If your portfolio doesn't pass the stress test and you still feel a financial crunch after you reduce non-essential spending, consider using some of your emergency fund cash reserve while you wait for the stock market to recover.
As a general rule, you should have at least ten months of cash reserves available in case the stock market takes longer to recover than expected or if stock prices continue to fall. Using your emergency fund is not a sign you'll lose money.
Emergency savings exist to help level out cash flow during a market crash or other situations where you might have a large expense. Don't feel shame or fear f0r using the savings you set aside for this very reason!
If you do use the cash reserve, make sure that you set aside money again to replenish the account once the stock market has recovered.
Market Downturns Don't Have to Destroy Your Retirement Plan
Even if your retirement account portfolio ranges from money market funds to mutual funds and bond funds to other conservative investments, you will still feel the influences of a market crash.
However, these downturns don't have to scare you away from retirement if you work with a financial professional and avoid panicking.
Eventually, consumer spending will improve, the market will swing upward, your retirement account will look stronger, and you will rest easy knowing your wealth management has helped you weather yet another wall street shock.
If you need guidance or want a financial professional to help run the numbers with you, I'm simply a phone call away. Meanwhile, you can listen to more personal finance and retirement discussions on the podcast, Ready to Retire!