A common concern among our clients is their income in retirement. When you’ve received a paycheck for much of your life the prospect of retiring and no longer having that recurring income can be really tough emotionally. This is how we help you recreate that paycheck in retirement.
A significant portion of the average retiree’s income comes from their portfolio these days. Invested assets will generate income from three sources:
- Interest on bonds and other types of bond like investments
- Dividends on equity and grow investments
- Distributions and capital gains; this is a difficult area to estimate since it can vary widely each year.
- You will also have Social Security payments at some point perhaps at your full retirement age of the latest when you are 70.Social Security is in effect an inflation adjusted bond, if you are receiving $2,500 per month ($30,000 per year) with bond yields as low as they are and assuming a 2% yield you would need to have $1.5M in bonds to generate that much income.
The remainder of your income will come from the capital gains distributions and possible liquidation of your portfolio each year. It is a common concern that people have that they are selling part of their portfolio each year to augment their income needs. As long as the net average total amount you withdraw from your portfolio does not exceed 4% annually, this should not be a concern. Multiple studies have shown that at a 4% safe withdrawal rate the odds are very high that you will not deplete your savings over 30 years. (We recommend you have detailed projections created since this is a general guideline).
Psychologically it may be useful to have money automatically transferred from your portfolio to your checking account each month automatically, we set that up for a lot of our retired clients. That is effectively part of your retirement paycheck with your Social Security and any other recurring income you may have.
The “Bucket” Approach
We use the “bucket” approach. To make sure you have reserves to meet that “paycheck” need and to also act as a buttress against market declines, you should have three buckets from which to draw funds:
- A cash reserve held in very liquid investments that are very low risk. This could be a money market account, savings account, and possibly very short term treasuries and CD’s. We typically recommend a reserve bucket that is the equivalent of 8-12 months of your cash flow need. This cash reserve should be automatically replenished from dividends and interest generated from your portfolio. It is also replenished when it becomes too low by rebalancing and also bonds maturing (if you have individual bonds as part of your portfolio).
- A bond reserve with the safest bonds in a bond portfolio created to meet your particular cash needs and circumstance. The amount held in bonds varies also depending on the portfolio allocation you have chosen. In any case it’s recommended you hold anywhere from 3-7 years’ worth of your spending need in the safest bonds. We suggest either municipal bonds, CD’s or government bonds, all of which have either very low risk or no risk associated with them. We do not recommend using corporate bonds since the additional yield does not justify the additional risk. Corporate bonds also have a nasty tendency to become “correlated” with the stock market during bear markets like the one we experienced in 2008.
- The third bucket are the growth assets you have in your portfolio, including large stocks, small stocks, REIT’s, etc. When times are good and your portfolio grows rebalancing these investment will periodically replenish both your bond bucket and also your cash bucket.
An advantage of this approach is it enables you to make it through a lengthy bear market without having to liquidate growth assets that might have declined in value. With the cash reserve and the bonds, you may have 4-8 years of protection against that happening. This is an important strategy to reduce the effect of “sequence” risk on your portfolio. For a detailed explanation of sequence risk read one of our past blogs.