Retirement Investing for the Faint of Heart
It can be scary retiring after a near lifetime of working. Perhaps even scarier is realizing that you must live on what you have now in investments. The markets daily ups and down with the television, radio, and social media hype only enhance this fear. How are you to do your retirement investing? Put them under a mattress or bank CD’s earning very little interest? Here is a method that works for my clients.
Determining Current Spending
Some folks want to know what they will have to live on during retirement. Others want to maintain or enhance their current lifestyle after working so many years. Regardless of which camp you lie in, it is important to understand what your actual expenses and costs of living are now. This is key to retirement investing and hard work for most people. Make sure to build in some flexibility into your spending plan as retirement lifestyle has a way of changing as we adjust to this new phase of life. Fortunately, there a variety of tools available to help. First, there is old fashion paper and pencil technique to record expenditures and income and see what goes in and out of accounts.
Second, are spreadsheets whether Microsoft Excel or Google Sheets both are basically electronic versions of the paper and pencil. Both Microsoft and Google offer templates to help create the spreadsheet, spending categories, and of course the formulas to make the math work.
Next are online tools. These are both free ones such as Mint.com and paid ones such as YouNeedABudget.com. I have tried both. These online tools allow you to link banking and credit card accounts so that you can at least partially automate the process and help from missing some financial transactions so to more accurately track spending. I favor the paid one as it does away with the advertising on free budget tools.
Next is determining what allocation between equity (stock) and interest earning (such as CDs, Bonds) is desirable given your total situation. A generalized starting point in the Alliance of Comprehensive Planners Conservation Life-cycle phase is 40% equities and 60% interest earning. This is conservative for reason. The idea is not to have a lot of downside while still capturing some growth to maintain purchasing power. Having a 60% in interest earning cushions the often-wild ups and downs of the stock.
Historically over time such an allocation helps retain the purchasing power of the portfolio. In addition, to handling the markets swings and associated emotions, I look at number of factors about your ability to handle the risk. Often other factors play a role such as supporting a boomerang kid, special needs person in the family or elderly relative. Sometimes the client might have enough income from pensions/social security and not need to access the portfolio for day to day expenses in retirement. These kinds of factors all indicate a need to personalizing the allocation to your situation.
First 6-18 months after retirement
One of the most damaging events that can occur to new retired folks is a market downturn. This is especially dangerous as folks need to withdrawal money from the now smaller portfolio to live. This withdrawal permanently reduces the capacity or longevity of portfolio and thus compromises financial independence. The industry lingo for this concept is “Sequence of Returns Risk.” There are couple of things you can do to mitigate this potential risk. First, have money (think cash, CDs) set aside for the first year or two of retirement so that there is not a need to draw down market-based accounts in case the market tanks. Second, is to make sure the portfolio allocation for this phase of life is desirable and often more conservative with less stock market-based investments.
Creating Cash Flow
Creating a flow of cash during retirement that is like the working years is important for many folks. This has become increasingly tricky process for clients as most do not have pensions in today’s economy. They must figure a way to access their pot of money to supplement guaranteed payments such as Social Security.
There are several ways retirees or those that are financial independent slay this problem.
- Take a fixed percentage from accounts each year.
- Purchase an annuity to create a monthly paycheck.
- Create bond ladder.
- Take money out a random (the default for some folks)
Generally, I favor building bond/Certificates of Deposit (CD) ladder to create the steady cash flow. A bond ladder is simply a method of purchasing bonds or CDs that mature for each time period or ladder rung. The amount of cash for each rung or year is based upon the amount of income needed above any pensions or social security. I choose to create such ladders for 15 years into the future. Historically, the market has not been down over periods greater than 12 years or so depending upon which research is referenced. Using 15 years provides some assurance over an extended decade long down market.
The bonds or CDs purchased are held to maturity, so market fluctuations of these interest-bearing securities are immaterial. Safety overrides yield and therefore I use exclusively US Treasury Strips and FDIC insured Certificates of Deposits. Usually, bond ladders are best held within tax deferred accounts such as IRAs.
These bond ladders as part of the interest earning allocation anchor the account against market wildness. At the same time, they provided set aside dollars for future retirement spending guaranteed by US Treasury.
Finally, the whole purpose of investing in retirement is to create the life you want–be it traveling, more time with grand kids, sitting by a lake, or working off a bucket list. As solid plan that generates cash flow while not having to worry about the wild market swings creates a peace around money that few enjoy. What a better time to enjoy financial peace during than during your precious retirement years.