How to Survive This and Future Droughts

We are once again in a rain drought in New Jersey – an annual event. Thankfully, we have not had a “drought” in the stock market for several years. For each of these occurrences, planning is needed. This helps investors be prepared rather than have to repair their portfolios.

As retirement income planners, one of our major challenges is how to sustain our clients income through what will likely be a longer retirement than any generation before them. This fact requires that most investors have a healthy allocation of their portfolio invested in the ownership of the great companies of the U.S. and the world. This ownership is known as stock or equities.

However, inevitability, the normal human response to this fact is the following question:

What about the volatility of the stock markets?

And by volatility, they mean the all-too-common stock market downturns or “droughts” as no one refers to the positive spikes as “volatility”. When this conversation occurs, we like to tell the following analogy.

When you retire, your investments will need to provide you with monthly income just as if you had a well in the backyard to provide for your monthly water needs. While the well would be subject to the weather conditions such as droughts and heavy rain resulting in the decrease and increase of water in the well, it is necessary to leave the water in the well so that through the natural weather cycles the well would provide an ongoing supply of water. This increase in well water results from various sources: the rainfall, snowfall and ice. To ensure that the well does not run out of water, you prepare for periods of severe drought – which have always occurred – by holding water in the house.

This is necessary because just as you are unable to determine when the droughts will occur, you and everyone else including the so-called market experts, will be unable to determine when the stock market droughts will occur. For both situations, foresight is recommended.

You should always have enough water to survive for several months so you will not need to withdraw from the declining water level in the well. Likewise, you should always have cash reserves (money not subject to the market conditions) to be able to handle the stock market droughts. Depending on your personal circumstances, a year to two years worth of cash reserves is recommended. This will allow you not to have to tap into your investments at all or at a reduced level during the market declines. This money can be held in a FDIC-insured bank account for the purpose of “insurance” against the market conditions and not to generate “return”.

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