Markets are a bit jittery as of late which can translate into jittery investors. I talked to a client this week that was a bit concerned about markets and the potential impact a “market downturn” would have on his portfolio. It ended up being a useful discussion about how to frame asset allocation in terms of time – let’s take a closer look.

I started the discussion with a quick reminder about why he’s investing at all. Simply put, your portfolio becomes your employer once you retire. And left “as is,” odds are your new employer will run out of money. Want to see for yourself? For the numerator, take you invested balance (be sure to tax effect it if you have any pre-tax savings in the mix). For the denominator, take the amount you need from your portfolio per year to live your life. My assumption is the resulting number (years of available funding) is below your life expectancy – and even if it’s close, this very simple math exercise excludes a lot of variables – such as inflationary impact on spending needs. Simply put – we invest to fund our futures. There is no other way the “math” works for most of us.

Knowing that we have to invest, the challenge becomes finding an approach that meets our unique needs but doesn’t cause too much emotional strain in the process. One key component of any financial plan is your asset allocation – ie: the amount of your portfolio that is held in each type of asset class (Cash, fixed income, US equities, and international equities are the main buckets but you can expand it to include private investments, real estate, commodities, etc. if you wish).

When concerned about the potential for a downturn and its impact on your portfolio, I always find it instructive to double-check your asset allocation by thinking of asset classes in terms of time – namely “number of years of spending held in each asset class” While any decline in your total balance can be upsetting, you need to remind yourself that you will not spend the entire balance at one time. You spend it over an entire lifetime. And a carefully tailored asset allocation does two things – 1) gives you access to cash when you need it without derailing your long-run return objectives and 2) allows your portfolio to reach its long-run return objectives by not subjecting it to drawdowns at the exact wrong time

Here’s how I like to look at it. If you are at (or approaching) a distribution stage, here are the minimum amounts of funds in hold in each asset class:

Cash & Cash Equivalents – funds you will to access to take in 0-1 years, such as RMDs or planned distributions in the current year (Note: this is separate from cash outside your investment portfolio, such as an emergency fund)

Fixed income – funds you will need to take in 1-5 years

Equities – funds you reasonably will not need to access for at least 5 years

Why this breakdown? If equity markets adjust downward (which they always have done and will likely continue to do at some point in the future), it takes time for them to recover. Economies (and the companies that make up their equity markets) go thru cycles and these cycles take time to play out. On average, drawdowns in equity markets take 3-5 years to recover to pre drawdown levels. This is an average – so you can lean more conservative than this, or more aggressive. But the general idea is you can withstand this volatility in equities if you can continue to live your life/access funds in the meantime.

Using this approach, even if there is an equity correction, cash flows from portfolio would continue uninterrupted for 5 years – avoiding any drawdowns of equity side of portfolio at depressed levels – since you hold the needed funding in cash and fixed income.

These are just starting points and there are other reasons to hold even greater weights in cash/fixed income (such as relative rate picture, desire for income generation, safeguarding for known future expenditures, etc). But at a minimum, if you are living off your portfolio, translate your asset allocations into years of spending as a gut check. It may help calm your fears about a market correction and allow you to stay the course – which is the ultimate goal.