Retirement Answers

Jacob: 00:00

With all of the volatility that's happening here in 2025 so far, you might be wondering what you can do to recession proof your portfolio. And I'm going to share with you some ideas today in today's Friday Q and A. The question this week comes in from Carolina and it says, what should be in my portfolio to make it recession proof? Stocks, bonds, treasury bonds? So that's her question.

Jacob: 00:20

She wants to know about portfolio construction and how to make her retirement portfolio recession proof. And so I want to talk about a few different ideas or concepts here. And then I want to share how I like to do this for my clients and how I structure portfolios. So when it comes to investing, we've really got to think about what is the purpose of the money being invested? What is it for and when do I need it?

Jacob: 00:43

So when I think about retirement, most of us think, oh my goodness, my time horizon is very short. I'm retired. I need my money because I don't have an income anymore. And that's partially true. We're gonna talk about that more in just a second.

Jacob: 00:54

But the reality is if you retire at age 60, guess what? You don't need all of your money today, right? You need your money today, yes. But you also need money for the next thirty, thirty five, perhaps even forty years. So you need your money to last for quite some time.

Jacob: 01:09

And if you think about that time horizon, you know, the next thirty plus years as your true time horizon, not just because you are currently retired, you begin to see, oh, I need money not for just right now, I need money in the future, which means I can and should be investing for that future purpose. So that's the first thing we gotta understand is that we have different purposes or different needs for money in terms of when we need it and what it's going to be used for. Now, in terms of volatility, most of us think of volatility as risk, right? If the market's down 20%, we lost 20%, that's risk and we don't like it. Well, my thought on this is that volatility is only a risk in the absence of time.

Jacob: 01:49

Okay, so let that sink in. Volatility is only a risk in the absence of time. So if we think back to what I just mentioned around time horizons, and how long you need to be planning for and how long you might need this money, volatility today kinda doesn't matter twenty years from now. So volatility only is an issue if you need money whenever something has gone down in value, which is why I'll talk about how I structure portfolios here in just a moment. So volatility is not the issue in and of itself.

Jacob: 02:17

It can be risky if we need to pull money from something that is volatile and is going up and down every single day, that's obviously a risk and sequence of return risk if you think about retirement. Now, whenever we talk about how often these big drops in the markets happen, something called we call a recession or a bear market, how often does happen? Well, they really only happen one out of every four years does the market go down 20%? And that's actually not too bad. So 25% of the years out there, you're gonna have a down market of 20% or more.

Jacob: 02:48

And so if you think back in time, really, there's not that many in recent history, you think about the .com bubble back in 2000, you got to think about 2008, obviously, that's the one we all think about. We had COVID in 2020, where we're down at the lowest point about thirty three percent from the high, although on the year it still closed positive. So the entry year swing in 2020 was huge. We think about 2022 when the market's down right at 20% year to date on that year, all the other years in between those different time periods, the market is positive. That's why the average over time in the stock market is about 10% annually.

Jacob: 03:20

So one out of every four years, can expect a down market. Now what happens even more often is a 10% drawdown, this could be entry year, right? So nearly every year, you're gonna have a 10% drawdown within that year. So in 2025, we've already had our 10% drawdown. In fact, we actually touched on the S and P anyway, minus 20% for about a day or two, and then it recovered and went back above that since then.

Jacob: 03:43

So volatility is a part of investing. In some sense, it's the price we have to pay to even get the returns we're looking for. And something I want you to focus on rather than the worry or the fear that pops in whenever we think about recessions or bear markets is I want to think about the opportunities that it creates. It gives you the opportunity to do a few different things, especially if you're in your gap years of retirement. Whenever the markets down, guess what, you can do Roth conversions at the most optimal time.

Jacob: 04:08

After your shares have gone down in value, you can convert more shares because the dollar amount per share is cheaper. Therefore, you can convert more shares to a Roth at the same price because you're paying taxes on dollars, not shares. So the best time to do a Roth conversion is when the market has gone down, and I would take advantage of it, because it's a huge opportunity. Another thing to think about is you could do some rebalancing, right, if your portfolio, if you've been kind of sitting on a cash position for longer than you'd like and you have an opportunity, when the markets down, you can get that cash and deploy it and buy it at that lower spot. So just know there's always a silver lining we can find even during tough times in the market.

Jacob: 04:45

Your investment plan is going to evolve and change over time. What I like to focus on here is I don't like to make major investment changes in terms of allocations or what we're investing in based on the environment around us. I really only want to make those changes whenever your life changes, maybe a health event changes, maybe your income needs change, maybe you have a big purchase that has to take place in the coming years, a new roof that has to be put on the house, whatever it might be, we can make adjustments to the portfolio and set aside different amounts of cash or fixed income based on those expected things that are upcoming, or if your life has changed. I don't want to make reactionary changes based on who the President is or isn't, I don't want to make reactionary changes based on policies or different economic cycles that we're going through. I want to make smart decisions and not be reactive, I want to make non emotional decisions have these things mapped out beforehand.

Jacob: 05:33

So with all this talk around just kind of investment philosophy, how do we actually put this into practice so that your portfolio, your retirement is secure during tough market cycles, bear markets, recessions? Well, if you've heard any of my episodes before, you know that I love to follow a three bucket approach. I'm a simple guy, I like to keep things as simple as possible because complexity just breeds confusion, confusion leads to anxiety, anxiety leads to bad decisions. Okay, so we wanna avoid complexity because bad decisions will come from that down the road. So keeping things simple is something I love to do.

Jacob: 06:03

In fact, one of my favorite quotes is da Vinci, he said simplicity is the ultimate sophistication. If we can follow that for most of our life, then we'll probably be doing okay. So how do I do this? What's a three bucket strategy? Well, number one, I want to have a certain amount of money sitting in cash on the sidelines and in a money market, not getting 0% of checking account, but not involved in the fixed income products such as corporate bonds, treasuries even, or obviously stocks.

Jacob: 06:27

So I want to have at least two years of living expenses in cash, ready to go at any given point in retirement. Think of that as your sleep at night factor, think of that as your cushion, gives you a little bit comfort and peace of mind knowing that if the market drops 40%, guess what, I can still live for two years, no questions on the same lifestyle, and if I want to pull back I can, but regardless, I've got two years worth of living expenses set aside in cash. The second bucket is our fixed income bucket. This can be made up of a few different things. It can be made up of corporate bonds, which I'm not so much of a fan of, but I do include them sometimes in portfolios.

Jacob: 07:01

It could also include things like treasuries, which I am a fan of, and it can also include the shorter term bonds, so think of like a six to twelve month duration. So really on this, I don't want to get locked into long term bonds, and here's why. If you look back to how corporate or long term bonds are performing since 2022 until now, it's not pretty. So whenever people think of bonds, think of risk free. Oh, it's not the stock market, it works in the opposite direction or inversely of stocks, and that's just not true.

Jacob: 07:29

If you look at what happened in 2022 with rates, they were really low and rates went up really fast. What that did was is it caused the valuation of bonds to go down drastically. In fact, it was like 15 or 18% down at one point. And what that tells us is there is risk that comes with bonds and the biggest one is going to be interest rate risk. So just know that bonds are not risk free, so don't think that they are, although we do want to hold them our portfolio, but we want to be thoughtful about which types of bonds we own, which is why it leads towards short term treasuries, two years or less in duration.

Jacob: 08:02

I don't want to own long term stuff here because if we wanna own something long term and take risk in that regard, let's just own stocks. And so for bucket number two, I want three years of living expenses there. So what that does is, is that rounds out about five years of living expense needs that would be in bucket number one and two, that you could tap and touch and go use if stock markets are not performing well for that long, which is a rare thing. So if you think back to 2008, it took about five years for the market to recover back to where it was in 2013. So that's obviously a an uncommon event, not to say it won't happen again, because it likely will, it's just a matter of when or how or why.

Jacob: 08:37

So I want to be prepared for that, and that's why I require at least five years worth living expenses combined in bucket number one and two, and now bucket number three is the stock bucket and everything else is allowed to be invested there. So that's the three bucket approach. At a minimum, you've got five years living expenses in those two buckets, you could have a little bit more than that, but we don't wanna be too heavy in cash or bonds because then you have a different risk that comes up down the road, which is purchasing power risk, meaning you're not growing or outpacing inflation enough to have money at eighty, eighty five, 90 to pay for perhaps your long term care needs. So you have to take risk in the long term in order to continue to have the same lifestyle that you might need in the future or cover additional costs that you might need in the future. So think of these buckets as a laddered approach in terms of when you need the money.

Jacob: 09:22

Bucket number one covers two years right now today. Bucket number two covers three years at a minimum in about three to five years from now. Bucket number three, the stock bucket covers expenses I might need to have in five years plus. So that's how I like to approach it. Obviously, there's some variability here, there's some nuance to this, there is a little bit of maybe you've heard of the guardrails approach or dynamic spending.

Jacob: 09:43

There is elements of that that we add in to where if we can cut back from 10,000 a month of spending down to 7,500 during tough market cycles, hey, it might be wise to do that. So we might do that. So that's a part of that dynamic spending that we might infuse into the buckets in general. But the idea with this approach is to set our investment allocations based on our income needs. And for you as the person navigating retirement, and as the person trying to sleep at night through these tough cycles, it gives you a framework to operate by and say, I know what I'm doing and why I'm doing it.

Jacob: 10:14

So here's the thing, build your plan, find a way to stick to it, expect bad times, get help if you need it. Those hard times come, which you've expected. One of the best things that you can remember is that when it comes to investing anyway, is that inaction is often the best action. Simply hold, go do something fun, go do something with a loved one, stop looking at the markets, don't pay attention to the TV, just go enjoy because you know that your portfolio is ready to weather the storm, and the more that you touch your portfolio, the smaller it's going to get. So Carolina, I hope this helps and gives you a framework to navigate these different market cycles and have a good solid foundation for your retirement plan.

Jacob: 10:54

And if you're like Carolina and you want to have your question answered here on a future Friday Q and A, what you can do is you can click on the link down in the description below that says enter or ask my question, and I'll receive that. I'll take it. I'll put some thoughts together. I'll respond right here on the show. And that's how you can have your question featured on a Friday q and a.

Jacob: 11:11

Other than that, I hope you have a wonderful weekend and we will talk to you again next week. Hey, it's Jacob again, and I wanted to remind you that nothing discussed in today's episode is meant to be financial, legal or tax advice. Retirement Answers is for educational purposes only. Thanks for tuning into this week's episode. I look forward to talking with you again next week.