Volatility Proofing Your Portfolio In Retirement

Can anything be done to mitigate market volatility? And do you even need to worry about it in the first place?

Let's start with the second question first. You know that money that's taken out of your paycheck each pay period and put into your 401(k)? (You are maxing out those contributions, right?) Market volatility means you are essentially reducing the average cost of your investments. To use an extreme example by way of explanation, if markets never did anything but go up, you would always be paying more and more for your stocks, bonds, and funds. Every two weeks, that pre-tax withholding on your paycheck would go toward at least slightly higher prices on your investments, raising your average cost each time. But because markets take a tumble on occasion, you're able to lower the average price you're paying. This is an example of dollar-cost averaging.

So to answer that second question: No, if you're still working, you don't really need to worry about volatility, and in fact you should welcome it. If you are going to be a net buyer of investments over time, you want their prices to be lower, the same as you would bananas or socks. And if you have a while (10 years or more) before you retire, you should be a buyer of stock investments. You should hope that the many predictions about near-term market performance are correct (that stocks won't do as well over the next 10 years versus the prior 10), because it will mean lower prices for you.

However, bear markets can and do blow up retirement plans if they hit at the wrong time . . . which is roughly right before or right after you retire. You don't want to be headed into retirement with a big slug of stocks that you are planning to sell to cover a large portion of your living expenses over time, only to have those investments' value cut in half by a recession another reason that leads to a spike in volatility.

The key, then, at least at a big-picture level, is to take advantage of the volatility in your working-and-investing years, and be wary of it and protect against it during (or as you get close to) your retirement years.

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