Retirement What retirees can do during a market downturn

1. Put returns into context
First and foremost, we need to override the fight-or-flight impulse to react to market losses. A portfolio designed using the Liquidity. Longevity. Legacy. framework is segmented into three key strategies according to specific needs and time horizons.

Segmenting wealth by purpose helps to make it clear that the money you need for spending today is safe. And, although your long-term investments have declined temporarily, our research on bear markets tells us that those losses will likely be fully recovered by the time those assets are needed.

This approach helps to reinforce the fact that market losses are short-lived and that they also represent an opportunity for investments that are earmarked for future spending.

2. Hold off on refilling your Liquidity strategy
A well-funded Liquidity strategy can help protect your retirement plan from sequence risk, because it allows you to meet your needs today without being forced to sell assets at bear market prices.

We recommend funding your Liquidity strategy with cash, bonds, and borrowing capacity using a “Three Tier” system. During a bear market, you can tap into each of these reservoirs in turn while you wait for a market recovery (at which point you can refill the Liquidity strategy by tapping into the Longevity strategy assets):

Tier I (Everyday cash) is earmarked for day-to-day expenses over the next 6–12 months. These funds should remain in highly liquid solutions, such as cash.

Tier II (Savings cash) are funds that are earmarked for other short-term expenses—those anticipated in the next two years. For these funds, investors should consider core savings, certificates of deposit, or money market funds.

Tier III (Investment cash) are funds dedicated to medium-term spending—the remainder of your Liquidity strategy’s 3–5 year time horizon. This part of your Liquidity strategy is only intended to be tapped during a bear market environment (in a bull market, the Liquidity strategy should every year). Therefore, we recommend carefully managing credit risk in these assets, since corporate bonds tend to be correlated with equities during volatile market environments. Tier III solutions include well-diversified fixed income portfolios, market-linked CDs, and CD ladders.

3. Realize capital losses
Over time, investments in your taxable accounts will accumulate significant capital gains. When you transition into retirement and begin to tap into your portfolio growth to finance your spending, it will likely trigger capital gains taxes.

Tax loss harvesting can help you to reduce this tax burden, and it can help add to the after-tax return potential of your taxable assets.

Because markets tend to go higher over time, and losses tend to be short-lived, the best way to implement tax loss harvesting is to make small trades in your portfolio throughout the year as opportunities present themselves, rather than only looking to make a few large trades toward year-end.

4. Rebalance
To make sure your portfolio doesn’t drift too far from your target allocation, we recommend rebalancing your portfolio periodically using an allocation-based rule of thumb—for example, if your portfolio's equity allocation goes more than 5% from your target (e.g., over 65% or under 55% if your target is 60%).

To implement rebalancing, you can trim your allocation to assets that have outgrown their allocation and use the sale proceeds to buy more of asset classes that have underperformed (and therefore have shrunk as a share of the portfolio).

If you have cash on hand, you could add to your portfolio as needed to bring the allocation back in range, which allows for “tax-free rebalancing” (because you won't need to realize capital gains taxes).

Rebalancing isn’t a call on whether markets will go higher or lower; instead, it is a strategy to help protect you against the risk that markets will not continue in a linear fashion. Especially when market trends reverse, rebalancing can help to enhance your portfolio's upside potential.

5. Accelerate planned Roth conversions
Roth IRAs are an attractive savings vehicle for retirement assets—they allow for tax-free income in retirement and are not subject to required minimum distributions during your lifetime.

Bear markets present an opportunity to accelerate planned Roth conversions for two reasons. The first is because all future gains will be completely income tax-free, instead of just tax-deferred, as long as the assets have been in the Roth IRA for five years, and you are at least age 59 ½ at the time of the withdrawal.

Another benefit of completing Roth conversions during a bear market is that it can help to reduce the tax cost. The reduction in tax cost can be especially high if you have both tax-deferred and after-tax dollars in your Traditional IRA.

Since the tax burden is based on the taxable portion of your Traditional IRA balance—meaning the amount in excess of any nondeductible (after-tax) contributions—a change in market value does not change the amount of your after-tax contributions.

As a result, a market drawdown will lower the portion of the Roth conversion that's subject to taxes.

Read the full report Modern retirement monthly: What retirees can do during a market downturn 27 May 2022.

Main contributors: Ainsley Carbone, Justin Waring, and Daniel J. Scansaroli

This content is a product of the UBS Chief Investment Office.

UBS Wealth Way is an approach incorporating Liquidity. Longevity. Legacy. strategies that UBS Financial Services Inc. and our Financial Advisors can use to assist clients in exploring and pursuing their wealth management needs and goals over different timeframes. This approach is not a promise or guarantee that wealth, or any financial results, can or will be achieved. All investments involve the risk of loss, including the risk of loss of the entire investment. Timeframes may vary. Strategies are subject to individual client goals, objectives and suitability.