Strategies To Position Your Investments For Distributions
Whether you are retiring or simply taking a gap year, it can be daunting to consider the reality of taking withdrawals from your investment accounts.
From a young age, we are taught to take a portion of our paycheck and save it for a rainy day into a bank accounts, 401k plan, or IRA, let compound interest run its course, and not worry about the peaks and valleys of the stock market.
However, we are not really taught to consider the fact that we will one day need to touch this account, in addition to remaining invested throughout retirement to keep pace with inflation. If someone retires at 65 and they live till 90, these funds still need to grow for the next 25+ years to ‘last’.
With all this in mind, think about the psychological shifts required / involved to begin initiating withdrawals from accounts that have been saved into and never touched for 30-40 years. We are used to a paycheck being deposited into our bank account every 2 weeks.
In my experience, retirees can have a tough time with this adjustment, especially when they consider the ‘what-if’ scenario of overspending and running out of money. However, there are several things one can do to reduce some risks and provide peace of mind along the way.
So, in today’s blog post we will walk through a few adjustments I work with clients to implement to ensure they (and their portfolios) are ready for this next phase of life.
Lifestyle Assumptions
Simply put – understanding your lifestyle needs (expenses) and where the income is going to come from to satisfy these needs.
Seems like a basic exercise, but again, instead of a paycheck, the majority of one’s income will be coming from investment accounts, which could theoretically be at risk of draining quickly if there are too many years of overspending, or if the account is underinvested for the timeline of life.
The key here is to account for all relevant expenses: mortgage payments, car payments, insurances, utilities, groceries, entertainment expenses, healthcare, TAXES (often forgotten about 😊), to name some common ones. Once we have this basic living expense figure, we also need to account for future / once a year expenses – future car purchases / payments, travel, wedding payment (for children or grandchildren), vacation home or boat purchase.
It is also prudent to account for some level of inflation (cost increase) for these expenses, as the value of $1 today will not equate to the same value (in terms of purchasing power) in 5, 10, 15+ years.
This is how we derive the notion that one’s investment accounts still need to growth (be invested) throughout their retirement years, as the cost of living will not remain stagnant.
Which leads us to our next section….
Income Sources & Asset Positioning
To begin, you should be aware of the amount of benefits your are eligible for through Social Security, from there, you can determine how much will be needed from your investments to fill in the gap.
**On a separate but related note - if you are lucky enough to have a pension (not many companies left!!), you may not even need to touch your investments until Required Minimum Distribution Age (RMD). So, this may not apply.
For today’s purposes, let’s assume a single client (age 65) needs $80k/year to live, and will receive $30k/year from Social Security – this equates to $50k/year from the investments.
To prepare for this distribution amount (and for the years ahead), I have clients reposition 1-3 years of income in their portfolio into a bond type allocation / stable assets class – this could be a money market fund, short-term bond, etc. So, for a client who needs $50k/year from their accounts, we set aside anywhere from $50k-$150k for future income purposes. Most of the time we err on the side of caution and set aside 2-3 years, rather than only 1.
What may come as a surprise, is that this adjustment usually does not change the overall allocation of a client’s portfolio.
Prior to retirement, if they are allocated to a 70% equity / 30% fixed-income / bond portfolio, we will most likely maintain the same overall allocation, but simply reposition funds on the fixed-income / bond side to be ready for these upcoming distributions. Now, if there is a reason to reduce risk in the account – higher anticipated one time expenses, or the client has over saved for retirement and does not need to continue to maintain this risk level to fund their lifestyle – then we will reduce risk accordingly, but in most cases, I find there is no need to.
This is the opposite of what most folks expect, as traditional wisdom may tell us - ‘I am retiring, I need to derisk to not run out of money or in a worst case scenario, lose everything in a stock market crash’. In my opinion, financial professionals who endorse the prior sentence are simply trying to instill fear, and make a case for an annuity or insurance strategy.
When in reality, your investments need to keep up with inflation to maintain purchasing power, and to do that, one does need to take some level of risk. Moreover, we do not have control over the pace of inflation, or timing / severity of swings in the stock market.
So, coming up with a systematic approach (as mentioned above) to raise income while still maintaining a diversified asset allocation can provide the following:
- Provides peace of mind that we have the income set aside in advance for the next 1-3 years, which….
- Buys us time
- If the stock market is experiencing some level volatility or the economy faces a recession (potential time for a market decline), we have bought ourselves time for the market to recover since the income needed is already set aside years in advance!!
- Allows the aggressive portion (equities / stocks) of the asset allocation to continually grow overtime (keep up with inflation)
- In addition to allowing us to harvest the gains from the equity / stock allocation to refill the income bucket for the next 1-3 years and so on
Of course, NO STRATEGY is foolproof or perfect by any means, but the above can allow for some level of control, choice and flexibility.
Now, if you are reading this and anticipate retiring soon, my advice would be to start planning NOW.
Typically, we have clients make adjustments for this approach at least 3-5 years in advance of retirement to ensure they are ready to rock & roll when the time comes.
If there are any questions, please do not hesitate to reach out.
Happy planning!
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give tax or legal advice.