Whether retirement savings will last throughout one’s remaining lifetime is a common concern for most everyone when thinking about withdrawals from savings to provide the necessary income to cover future spending.
Calculations can be made to determine the required level of savings needed to provide for any assumed amounts of future spending. But, when that time comes, you should have an effective and efficient withdrawal strategy that will help manage for any future investment market volatility.
In doing this the overall objective is to make it unlikely that future market volatility will negatively impact the annual amount of income available for withdrawals to satisfy your future income needs.
A good way to accomplish this is to set up three (3) or more “buckets” containing different types of assets and different time horizons for their use to meet future income needs. This approach will also help to overcome today’s reality that adequate pension incomes have become rare and social security alone will not cover future spending needs.
In the past, retirees could invest savings in government bonds yielding high levels of interest, which reduced the need to include much more volatile stock market investments. Portfolios of the past generation of retirees were mostly invested high-quality bonds.
Today, (with 10-year government bonds yielding very low returns, longer life expectancies, high health care costs, and the potential for higher inflation) retirees will find it necessary to allocate a larger portion of their savings into more aggressive stock market investments. This has forced many retiree portfolios to take on more risk than wanted, making them more susceptible to significant and permanent damage from negative stock market periods.
Everyone knows that stock prices rise and fall by very substantial amounts in short periods of time. Having a “bucket” strategy will help offset the additional risk and volatility that is inherent in allocating a larger portion of your retirement savings to stock market investments.
Obviously, the inevitable periods of decline are what needs to be overcome. If stock values fall at the wrong time (Sequence Risk), one’s retirement savings and outlook for future income can be devastated. A large decline in stock prices occurring in the beginning of the withdrawal period when retirement is starting can cause retirement savings to be depleted much sooner than when a similar decline happens nearer to the unknown end of one’s retirement lifespan (Longevity Risk).
The 2008 “Great Recession” stock market crash provides a good example of the damage that can be caused. The decline immediately caused many retirees income generating assets to decrease by 30% to 50%. This forced many to postpone their retirements and others, who were already retired, found themselves having to go back to work at any job they could find.
A Bucket Strategy Mitigates both Sequence and Longevity Risks:
· Bucket #1 (Market Volatility Protection) should contain enough money to cover any projected savings withdrawals that are needed to provide one (1) to two (2) years of secure income. It should cover regular monthly expenses plus an extra amount to cover the potential for unexpected expenses. Cash and cash-equivalents, such as very short duration bonds should be utilized to provide the funding for this bucket. So that other market sensitive investments will not have to be liquidated at temporarily depressed prices, this bucket will also be the primary source for funds during the inevitable “bear” market periods. There are other benefits that are derived from having a cash reserve. It will help keep market sensitive investments from being either sold “low” and/or bought “high” and can help keep one’s emotions from interfering when making ongoing investment decisions in managing your investment portfolios.
· Bucket #2 (Income Generation for intermediate years) should contain enough money to cover any projected savings withdrawals that are needed to provide living costs for the next five (5) to eight (8) years. Ideally, the money in this bucket should be invested in high-quality fixed income securities that are “laddered” to mature when needed to provide income that will cover your actual annual spending during this period. This will enable your retirement portfolio to generate the needed income, even if it is during a time when stock prices have fallen.
· Bucket #3 (Portfolio Growth and Inflation Protection) should contain the retirement savings that remain after fully funding buckets #1 and #2. It will cover future projected income needs for the years beyond your intermediate years funded by bucket #2. It should be invested 100% in equities (stock) to produce enough long-term growth to help achieve an overall return that will enable your savings to last for the duration and fund any legacy objectives. An investment time horizon exceeding seven (7) years provides the necessary time for a diversified portfolio of equities to generate higher returns that will be used to replenish the funds in buckets #1 and #2 to keep them fully funded.
Conclusion:
Retirees will typically have a combination of taxable, tax-deferred, and tax-exempt accounts. Long-term investment markets history has shown that safe withdrawal rates for portfolios that are invested 60% in equities and 40% in fixed income has averaged 6.5%. Whether you will achieve similar results will depend more on how successful you are in avoiding losses during the earlier years of retirement. Using a “bucket” approach in allocating your old and new retirement investments will help reduce both “sequence” and “longevity” risks and help provide a steady income for a more relaxed and financially worry-free retirement.
Greg Tinaglia
Last Updated: 01/08/2017