Roller-coaster markets can send a new retiree's heart aflutter. These strategies can make the thrill ride less scary. By Rachel L. Sheedy, Editor and Kathryn A. Walson, Staff Writer May 1, 2008 EDITOR'S NOTE: This article was originally published in the March 2008 issue of Kiplinger's Retirement Report. To subscribe, click here.Fresh retirees and those nearing retirement may well be keeping one eye on the stock market and the other turned toward the heavens, wondering why they're being tested like Job. The turmoil in the markets certainly causes suffering for all investors, but none more so than those who have started or are about to start tapping their portfolios for a lifetime of income. RELATED LINKS Preparing for a Smooth Exit Turn Savings Into Income Knock Down Your Drug Costs A downturn just as you're about to reverse gears can seriously chew up your nest egg. If your $1 million portfolio suddenly plummets to $800,000, your carefully planned 4% annual withdrawal of $40,000 is squeezed to just $32,000. There goes that long-awaited trip to Rome. Ask anyone who retired as the dot-com bubble burst: It's very difficult to regain your losses if you begin to draw on investments as the roller coaster takes a downward plunge. If you're about to reach for the antacids, hold off. For soon-to-be and recent retirees, there are some strategies you can employ that will make the roller-coaster ride a little less heart-stopping. Advertisement Our first piece of advice: Don't panic. Take a hard look at your asset allocation, cash flow and spending. But don't abandon the stock market -- selling off at a low point -- and move into cash or bonds, which are not exactly going gangbusters either. "You don't want to be out of the market, and you don't want to time the market," says Philip Lee, a certified financial planner with Back Bay Financial Group, in Boston. Lee recalls one client who moved entirely into cash during the market swoon of 2001-02. "He missed participating in the market upswing of '03 and '04," says Lee. Paul Rippas, 58, a vice-president of a distribution company who lives in Branchburg, N.J., and is a couple of years from retiring, is "sitting tight" when it comes to the market. His wife, Janice, 62, has retired from her teaching job. Last year, Rippas hired a financial planner, who rearranged his portfolio, and he'll ask the planner to crunch the numbers in two years to make sure he's ready to retire. Even with the market uncertainty, Rippas is confident that he and Janice will have enough from her pension, his 401(k), a Roth IRA and Social Security. "I've done due diligence and feel I'm on the right track," he says. "I've been down the road before, panicking and trying to get out, and that doesn't work." The message is clear: If you have a well-diversified portfolio going into a down market, there's no reason to shake things up. If you don't, this is a wake-up call. Advertisement Postpone Tapping Your Stocks Even if you've already retired, you could be in better shape than you think. Many advisers suggest having a cash reserve, to protect you from having to dip into stock during a slowdown. Beyond such a reserve, you may have enough from pensions, Social Security, annuity payments, bond interest and dividends to cover a good part of your expenses. If you need to raise income by selling some stocks, review your asset allocations. Market swings may have thrown your allocations out of whack. You should sell stocks in the asset categories in which you are now overinvested. When you rebalance your portfolio, you may need to shop for stocks for underinvested categories. The beauty is that such rebalancing often means selling high and buying low. Indeed, this may be a great time to look for solid, blue-chip stocks. "In times like we're in now, the companies that tend to perform better are large companies versus small and midsize companies," says Mark Johannessen, president of the Financial Planning Association and a certified financial planner with Harris SBSB, in McLean, Va. "Those that also seem to weather the storm that we're in right now are growth companies rather than value companies." Other advisers warn investors not to get too hung up on trying to predict which asset classes -- large company versus small company, domestic versus foreign -- to buy or sell. "This is more about creating balance and not trying to cherry-pick short-term investment strategies," says Troy Von Haefen, a certified financial planner in Nashville. Advertisement Johannessen, Von Haefen and other experts agree that diversifying your holdings is a key strategy to weathering a volatile market. The more asset classes your portfolio holds, the less volatile it will be, according to research by Craig Israelsen, associate professor at Brigham Young University. He says investors should hold at least seven asset classes -- large and small U.S. stocks, foreign stocks, cash, real estate investment trusts, bonds and commodities. Israelsen tested the returns and volatility of several portfolios between 1970 and 2006, using an original withdrawal rate of 5%. He found that a portfolio split evenly between U.S. large- and small-cap stocks produced an annualized return of 10.7%, but lost 30.8% in its worst year. His seven-asset portfolio, split evenly among all classes, provided an 11.2% return, but its worst-year loss was 10.2% -- the lowest of any of the portfolios. One lesson: The portfolio with lower risk actually produced a higher return. Looking for safety? Make sure your portfolio has enough fixed-income investments to give it some ballast -- about 40% for someone who is newly retired. Find the best rates on short-term certificates of deposit, and consider Treasury inflation-protected securities to hedge against an inflationary cycle. Although bond rates are low, Von Haefen notes that a recession could drive rates lower. "I would want to see at least some downside protection through Treasuries," he says. Advertisement Stretching Your Nest Egg If your various income streams are not enough, consider some lifestyle changes. For instance, by staying in the workforce a little longer, Rippas, the New Jersey manager, could ride out the storm. "When you work for an additional year, you have one more year's savings -- and that's less time in the withdrawal phase," says Sri Reddy, who heads retirement-income strategies for ING US Wealth Management. Depending on your age, working longer could also enable you to postpone the year you start claiming Social Security benefits. If you claim before your full retirement age of 66, your benefits will be reduced for life. Of course, if you need the extra cash now, claiming Social Security earlier could help you avoid dipping into a shrinking nest egg. Look to your home for extra money, perhaps moving to a smaller house. As home values drop, you'll need to figure out whether the lower cost of the new house is worth the hit you might take on your current house. You'll also need to consider taxes, heating bills, moving costs and settlement fees. If you don't want to move, consider refinancing to raise extra cash. Although credit markets are roiling, mortgage rates are generally lower than they were a year ago. Eve Kaplan, a certified financial planner in Berkeley Heights, N.J., says homeowners should avoid taking out a reverse mortgage because of its high costs. Also resist the urge to pay off your mortgage. You may be getting rid of an extra expense, but you don't want to pull assets from a declining portfolio to accomplish that. If you're downsizing, put some of the tax-free profit you realize into a cash reserve to protect you in future market downturns. Penny Marlin, a certified financial planner in Delray Beach, Fla., advises clients to set aside one or two years' worth of expenses in a money market or a short-term CD ladder. "That way they can have their spending needs covered," she says. Toby Pearlstein, 55, who retired at the end of December, set up a cash reserve as part of her retirement planning. For two years, she socked away cash into an online savings account, including a bonus she received when she retired as director of information services for a company near her home in Revere, Mass. Pearlstein has not started to withdraw from her portfolio yet, and she intends to draw on the cash cache for five years. Is she worried about the market? "I'm a little bit ruffled, but not worried," she says. "The cash reserve gives me peace of mind." Charles Stanley, a certified financial planner with Capital Financial Advisors in La Jolla, Cal., says buying an annuity "to meet baseline expenses" is an option for people who can't handle volatility. This would work best if you don't have to tap your portfolio to buy the product. Stanley prefers immediate annuities, but a growing number of advisers are looking to variable annuities with "living benefits" for individuals who are approaching or newly in retirement (for more information, read Annuities With New Promises). Variable annuities differ from insurer to insurer, but they basically allow you to withdraw money at 5% or 6% a year, regardless of market performance. "They have a certain guaranteed income stream that can go up if the market goes up, but if the market goes down, the income stream does not," says Steven Feiertag, a financial planner in Royal Palm Beach, Fla. These products are expensive and complex, so make sure you buy one from a reputable adviser. Of course, another defense against budget pressures is dialing down spending. This may mean opting for a cheaper model than your dream auto. "Do you really need the Mercedes-Benz?" says Gary Webb, of Webb Financial Group in Bloomington, Minn. But try to have some fun. If you're still in the workforce, it won't be the end of the world if you cut back on your 401(k) contributions. Sure, contribute enough to get the company match, but divert some of the rest to pay for that well-deserved cruise, says Christine Fahlund, senior financial planner for T. Rowe Price. Trimming your final contributions won't have a big impact on your bottom line, she notes. "Don't delay the gratification," she says. That cruise could surely improve your state of mind in these rocky times. For more authoritative guidance on retirement investing, slashing taxes and getting the best health care, click here for a FREE sample issue of Kiplinger’s Retirement Report.