How money market accounts let you keep more of your retirement cash

A chilling statistic: According to the Center for Economic Policy and Research, the generation now approaching retirement--people between ages of 55 and 64--have seen their net worth cut by an average of 49 percent from 2004 to 2009. The chief culprits were sharp declines in housing prices and in the stock market.

The mathematics of losing money are brutal. If you ever lose half your investment, you then need to double your remaining money just to return to your initial investment value. If you lose half your investment on the verge of retirement, you may very well not have time for such a comeback.

The rainy day fund

A recent Forbes article suggested a use for money market accounts or similar deposit vehicles that goes beyond the traditional three- to six-month emergency fund. If you've felt your retirement nest egg threatened by financial volatility, the concept is worth exploring.

The idea is simple: building up a two-year "rainy-day fund" to tide you over in times of financial hardships. This rainy day fund would be put into a money market account or other interest-bearing vehicle that allows reasonably immediate access while still offering some return.

Ripple effects of financial trouble

Why would it make a big difference to have a rainy-day fund as you near retirement?

Financial troubles tend to create ripple effects that pile on one another. In the recent recession, millions of Americans found that their homes and stock portfolios declined in value--and that they lost their jobs. Often, having this kind of double or triple whammy means dipping into depleted assets just to meet living expenses.

But if you're forced to tap into a stock portfolio when prices are down, you blunt the ability of your portfolio to bounce back. You're effectively limiting your participation in the next upturn. As it happened, the U.S. stock markets mounted a pretty dramatic rally after hitting bottom in March 2009. Anyone who was previously forced to liquidate stocks before then had to sit on the sidelines.

Similarly, people who could no longer afford their mortgages may have been forced to sell their homes at the worst possible time.

Those who were forced to tap into their retirement accounts early not only sold at a low point, but also likely incurred tax penalties for those early withdrawals. And anyone forced to opt for early Social Security payments would have found their benefit permanently reduced.

Money market accounts to stop the ripple effects

The rainy-day fund approach gives you more of a cushion in case of financial distress--before you have to dip into assets with fluctuating sales prices, like stocks or real estate. That additional time could allow you to find a new job or give asset prices a chance to recover a little before you potentially decide to sell.

Of course, the downside to this method is that a bigger allocation to cash in money market accounts can reduce your total retirement portfolio return potential, especially with money market rates as low as they are today. But when so many are faced with a negative 49 percent return on all their assets over the last five years, gaining the 1 percent from money market rates for a small portion of your portfolio doesn't sound so bad.

Showing 0 comments | Add your comment