Why retirees still require rainy day funds

Retirees may be finished working, but they still need to remember the old Boy Scout motto: “Be prepared.”

The Covid pandemic reminded the world of life’s uncertainties and how powerful unseen forces can arise to upend one’s existence, both physical and financial. For those in the workforce, for example, so-called spending shocks, or large irregular expenses like a broken car or refrigerator, can occur at any time, as can job losses. That's why wealth managers advise their working clients to maintain a separate pool of emergency savings they can dip into to pay for such uncertainties, while simultaneously keeping their retirement savings intact.

According to J.P. Morgan Asset Management's 2023 Guide to Retirement, workers typically encounter spending shocks about once every three months, a far greater frequency than so-called income shocks, larger and longer lasting financial surprises that tend to take place about once a year. J.P. Morgan’s retirement team recommends those still in the workplace consider setting aside two to three months of pay to combat spending shocks.

Retirees, on the other hand, encounter spending shocks in larger amounts than workers, likely as a result of unpredictable costs such as health care. As a result, J.P. Morgan’s experts advise those in retirement to set aside rainy-day funds holding three to six months of income to prepare themselves for major life, health or financial surprises.

“If people don’t have immediate liquidity, often times they have to liquidate their retirement portfolio to generate the cash," said Kelly Hahn, a defined-contribution strategist at J.P. Morgan Asset Management. "For retirees, the immediate liquidity needs can come from emergencies like a car breaking down and volatile spending needs such as health care, which can be unpredictable in terms of how frequently it happens and how large the size may be.”

John Robinson, founder of Financial Planning Hawaii, also believes retirees need to put funds in reserve for a rainy day. In his view, however, J.P. Morgan’s suggested amount is far too low.

Robinson says he typically recommend retirees have five to seven years’ worth of expected portfolio distributions set aside in stable, accessible investments. These days that means online savings accounts, U.S. Treasury money-market funds, Treasury bills and CDs. 

“Portfolio sustainability is a big worry for many retirees, and the fastest way to run out of money before running out of time is to be forced to sell stocks in the portfolio during periods the market may be down," he said. "Keeping five to seven years’ worth of expenses in these investments ameliorates this risk and also serves the purpose of having funds available to meet unexpected exogenous expenses.”

Luckily, interest rates are now in the 4% to 5% range. So, when it comes to keeping significant portions of retirement portfolios in these asset classes, it's much more palatable, and maybe even profitable, to be prepared these days.