In my last monthly update on our retirement savings, I wrote a little about reinvesting dividends and my speculation on how that all played into whether or not someone loses money during a drop in the market, if they do not pull out.
I haven’t consulted a financial expert about it, but I did look into it a little more and I am confident that is the way it works – that if you do not sell any of your retirement stock holdings, when it goes back up, you would have lost no principal or growth. It is simply worth the current share value because all of the growth was reinvested in shares.
The news I heard after the crash in 2008 was very misleading. It was story after story about people near retirement that had to keep working because they lost half their retirement savings or retirees that needed to go back to work for the same reason.
I never heard any stories about how those same people, especially those not yet retired, just had to wait for the market to recover. But that’s the news for your. All they talk about are house fires, murders, and anything doom and gloom. Except the occasional story about a dog rescuing a baby.
During my investigation of the subject, I looked at my Vanguard activity and found that all of my dividends were being reinvested into those holdings in fractional shares.
Learning about reinvesting dividends makes be feel even better about retirement. Not only do we have compound interest working for us, with the dividends being reinvested, that adds to the compounding.
I did read this quick little article that touches on how to weather down turns. It boils down to saying the same things I’ve read in the last couple of years. When the market goes down, don’t sell. Pretty simple advice. Lesson 4 is something I didn’t think of before though, as an added hedge of protection outside of an emergency fund.
As I learn and grow my knowledge about investing and retirement, I think there are some key factors to keep from panicking and either pulling out of your investments at the wrong time or not being in a position to hold your ground until a recovery.
Pay off your mortgage before retirement
As I wrote about at the beginning of this blog, we paid off our mortgage a couple years ago. I feel faint when I’m listening to a financial podcast and hear a caller say they are 68 and have $250,000 left on their mortgage.
If you are going into retirement, do it mortgage free. Even if that means selling your beloved home and downsizing into something you can pay cash for. Getting that noose from around your neck will have a huge impact on how much you need to withdraw from your retirement savings in a down market.
Do not invest in individual stocks
During a real crash, no one is unscathed. But having your holdings diversified in mutual funds, ETF’s, or index funds will take the sting out of it. Putting all of your eggs in individual stocks will just increase your risk. It’s not about being fun and exciting. It’s about being able to live comfortably in retirement.
Christy has an auto mix of 90% stock mutual funds / ETFs and 10% bonds. In my Vanguard account, I hold ETFs in the four categories recommended by Dave Ramsey. 25% each in Large Cap, Mid Cap, Small Cap, and international. Well, almost 25%. I have to buy shares each time I transfer money and I try to keep it as balanced as I can.
Invest in Roth IRAs and Roth 401Ks
Some financial professionals say that you should invest everything in traditional investments to get the tax advantage of withdrawing it at a lower tax rate in retirement. I am far from a financial professional, but I have ran those #s before and even at a lower tax bracket, Roth came out ahead.
I would recommend investing everything in Roth. Think of it this way. Would you rather get a slight tax break each check or pay taxes on 1 million dollars worth of growth in retirement?
Plus, since Roth contributions are after tax, your withdraws do not count as earned income so they will not trigger a taxable event on your social security benefits.
A good strategy on that would be to withdraw just under the taxable threshold (currently less than $32,000 for married couples filing jointly) from your traditional retirement savings (which by law, employer contributions must go into), add your social security benefits, and then withdraw the remainder of what you need to live from your Roth accounts to avoid paying taxes on your social security benefits.
In our case, we could withdraw $30,000 from our traditional 401k funds and have have $55,044 with our social security added to that. Then we could withdraw the remainder from our Roth accounts, including any money needed to pay taxes on the $30,000 from traditional, and get our entire social security benefit tax free.
Overshoot your retirement goals
Christy and I would be just fine if we retired with $1.4 million or even $1.3 million and we could get by on a 4% withdraw rate to cover our basic needs if we had to. The reason I’m shooting for at least $2 million in retirement is because I want enough padding in our accounts to make it through a crash and not eat dog food during the inevitable downturn.
So bring on the down markets. I don’t hope for them because they will affect others, but until we retire I’m not worried by them. I just see them as a buying opportunity to make us stronger in retirement.