October 20, 2010

By: Rande Spiegelman

During the past decade, two severe bear markets have taken their toll on even the most- well-built retirement portfolios, leaving many people wondering what to do. Here, we attempt to answer some of your most pressing questions about retirement savings.

I'm facing hard times. Should I tap into my 401(k)?
Doing so should be an absolute last resort, as it'll end up costing you. If you're under age 59½, you'll pay a 10% federal penalty and income taxes on the withdrawal (state taxes and penalties may also apply), and you'll give up potential compound growth. So please explore other options—such as reducing your expenses, finding a second job, and getting help from family or friends—before tapping your retirement plan.

Borrowing from your 401(k) is a second-to-last option. Keep in mind, if you take out a loan from your 401(k), you'll have to pay the loan back with after-tax dollars. And if you leave your job, your loan balance will be due when you leave.

My portfolio keeps losing money. Can I still retire as planned?
A good place to start is our Retirement Assessment tool. By entering an estimate of your portfolio value and other information, you can find out the likelihood that you'll be able to sustain your desired spending throughout your retirement.

If you're not quite there, don't panic. Think about trimming expenses, increasing savings, and/or delaying or easing more slowly into retirement. Your retirement decision is ultimately about what you want and what you can pay for. The best approach is to analyze the situation and adjust as needed. But act soon—small changes now work out better than being forced to make big adjustments later.

Given the market's moves, should I change my investment mix?
Avoid changing your long-term portfolio asset allocation because of short-term market behavior. Unless you've just realized that you're not as risk-tolerant as you thought, now is not the time to abandon your long-term plan. It's a good time to think about rebalancing your mix of stocks and bonds to your long-term target allocation—for instance, if your portfolio originally was 60% stocks/40% bonds, but has shifted to 40% stocks/60% bonds because of the market (see Build Your Retirement Portfolio to Last).

I sold my stocks because I was nervous. When should I reinvest?
If you got that nervous, consider whether you belong in the stock market at all and, if so, to what extent. If you can tolerate a minimum amount of risk, you should have at least 20% of your portfolio in stocks as an inflation hedge. Consider gradually reinvesting that money over the next year. That way, you'll ease into the market without the regret of being too early or too late with a lump sum.

As a retiree, how big of a cash cushion should I have?
Set aside enough cash to cover your routine expenses for one year (minus what you expect from reliable non-portfolio sources of income, such as Social Security). Keep that money in a relatively safe place, such as a savings account. Or consider investing some of your cash in a money-market fund or short-term certificate of deposit (CD).

You should also think about keeping an additional two to four years' worth of portfolio spending in high-quality short-term instruments as part of your fixed-income allocation. That way, in the event of a long bear market, you can cash them out instead of selling stocks or longer-term bonds at the worst possible time.

How much can I safely withdraw during retirement?
We believe a good rule of thumb is to withdraw 4% of your portfolio in the first year of retirement, and increase that dollar amount every year by the rate of inflation. That way, we estimate a conservative-to-moderate portfolio has a 90% chance of lasting for 30 years. The 4% rule assumes there will be bear markets along the way—that's why it's the 4% rule and not the 10% rule.

Theoretically, you should still be able to withdraw your inflation-adjusted amount at a 90% confidence level. Of course, in the real world, it's still a good idea to stay flexible. During adverse market periods like the downturn earlier this year, you might want to take out only enough to cover non-discretionary expenses—or at least forego the annual inflation increase on your withdrawal amount (see Write Your Own Retirement Paycheck).

Can I count on dividends going forward?
The average dividend yield on the S&P 500® Index is currently around 2%. So if you see a stock that's paying an unusually high dividend rate, remember that you normally don't get extraordinary yield without increased risk.

In this environment, return of investment is as important as return on investment, so beware of chasing yield. If you seek dividend-paying stocks, we recommend focusing on stocks that are rated highly by Schwab Equity Ratings®. For mutual funds, clients can check out Schwab's Mutual Fund OneSource Select List®. Either way, consider a total return approach—that is, combining dividends, interest and share sales for income (see Generating Cash Flow From Your Retirement Portfolio).


Important Disclosures
Investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.

Charles Schwab & Co., Inc. member SIPC, receives remuneration from fund companies participating in the Mutual Fund OneSource™ service for record keeping and shareholder services and other administrative services. Schwab also may receive remuneration from transaction fee fund companies for certain administrative services..

Schwab Equity Ratings are assigned to approximately 3,000 of the largest (by market capitalization) U.S.-headquartered stocks using a scale of A, B, C, D and F. Schwab's outlook is that A-rated stocks, on average, will strongly outperform, and F-rated stocks, on average, will strongly underperform the equities market over the next 12 months. Schwab Equity Ratings are not personal recommendations for any particular investor. Before buying, investors should consider whether the investment is suitable for themselves and their portfolio.

The S&P 500® index is an index of widely traded stocks.

Indexes are unmanaged, do not incur fees or expenses and cannot be invested in directly.

This report is for informational purposes only and is not an offer, solicitation or recommendation that any particular investor should purchase or sell any particular security or pursue a particular investment strategy. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Past results are not indicative of future performance. Examples provided are for illustrative purposes only and are not representative of intended results that a client should expect to achieve.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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