Bear markets are a fact of financial life, but they’re riskier for those who are close to or in retirement. Retirees who pay expenses from their portfolios can get a double whammy: not only do they lose principal due to the stock market drop, but the depletion in savings cuts into the portfolio’s ability to rebound.
To determine how to “mitigate” this problem, UBS Financial Services designed the Bear Market Damage Index, largely “to assess how much portfolio depletion risk is [in a portfolio],” Justin Waring, investment strategist Americas for UBS, told ThinkAdvisor. He authored a study with Michael Crook, head of Americas investment strategy for UBS.
That a diversified portfolio reduces risk is nothing new, but beyond that UBS suggests a “liquidity longevity approach” to prevent a bear market from taking a larger bite out of a retirement portfolio.
This means a having a separate cash/short-term instrument account that “meets cash needs and keeps the lights on, and doesn’t expose savings capital,” Waring explained. It should be enough to last 74 months, which takes into account a market drop, plateau and rise.
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However, to do this advisors must know a client’s lifestyle expectations and cash flow needs.
To calculate a portfolio’s BMDI, UBS runs “a simulation of the portfolio’s value after withdrawals up until the end of the longest-ever bear market window,” the paper states. This means BMDI is calculated as a percentage of the portfolio’s depletion, indexed to 100.