Protecting Your Nest Egg

We’ve been talking about why investment risk matters most right at retirement. First, that’s typically when you have the most invested and, therefore, the most to lose. And, that’s when your ability to recover from a financial setback becomes increasingly limited due to the shortening length of time before you need the money, and your gradual consumption of your financial assets, leaving less and less to provide future growth and income.

How do you manage this risk? Diversification is the usual answer, and this definitely is important for the longer-term portion of your investment portfolio. But, at times like we saw earlier this month, nearly all asset classes can plummet in price at the same time in response to a market shock.

So, the only sure way to avoid suffering losses at the wrong time is . . . by not taking price risk with the money you will need to live on as you await the market recovery.

Are those “duhs” I’m hearing?

We all wish there were an easier answer, but the only sure way to eliminate this risk is with the classic rainy day fund – a cushion of liquid reserves invested in price-stable investments. These include share savings accounts, time deposits, money market mutual funds, and short-term bonds. (They could also include stocks and long-term bonds protected by some kind of options or futures hedge, but this effectively turns them into short-term, lower return assets and is a complex undertaking not suitable for most investors.)

The goal is to have cash reserves sufficient to never have to sell long-term investments when they are at depressed prices. This, of course, raises two more questions: How much do you need in liquid reserves? And, how do you know when prices are “depressed?” Tough questions. Any suggestions?