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Planning for the Withdrawal Phase of Early Retirement
Old 04-05-2011, 03:07 PM   #1
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Planning for the Withdrawal Phase of Early Retirement

I am confused about some aspects of the "withdrawal" phase of establishing an FIRE plan. When the withdrawal phase begins, I will need secure income from my investments in order to pay for monthly expenses. I believe that at the point of retiring, my asset allocation will need to shift, and the majority of my investments will need to be in bonds. For example, I believe 30 years treasury bonds are currently yielding, on average, 4.48 percent. Say I need approximately $60,000 in annual income. That would mean I would need $1,339,285.00 invested in 30 year treasury securities (or something with a similar risk/return profile) in order to generate the annual income that I would need from my investments. But if all of my investments were in bonds, then my asset allocation would not be optimal and I would probably suffer from the consequence of inflation.

I know that I am leaving Social Security and a small defined benefit pension (for which I am eligible) amount out of this analysis. But I may want to retire early enough that Social Security and a defined benefit pension payment would not kick into effect for a long time (say 20 years for SS and 15 years for pension).

When I use FIREcalc, I get the impression that I could retire with less than the $1,339,285.00 amount. I guess my question/concern is, how do I allocate my investments as I approach my early retirement age, in an effort to ensure both that I have enough put into fixed securities in order to meet my monthly expenses, but also factoring in the effect of inflation and the need for stock investments to address that? If you do keep a portion of your investment in stocks, and the income from your bond portion is not meeting your monthly expenses, do you just sell (on an annual basis) a portion of the stock investment that has done particularly well in the last year and use that amount to make up the difference?

If that number, $1,339,285 (or higher), is what I would need to have in order to achieve my early retirement goal, I feel like I am a very long way off from achieving that goal!

Thank you for your advice.
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Old 04-05-2011, 03:33 PM   #2
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It looks like you are not considering any draw down of your "principal" at all and just living off the anticipated yield?

For most, planning includes not only yield of investments, but also drawdown of total assets over time. Regardless of the planning software/tool you use, they normally look at your plan in the same way.

Now, if you are talking about just living on dividend/yields during the retirement phase (to leave a substantial legacy), that is another situation.
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Old 04-05-2011, 03:35 PM   #3
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If I could withdrawal safely from the principal too, I would do that.
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Old 04-05-2011, 03:40 PM   #4
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You might find this to be a good resource.

Amazon.com: The Bogleheads' Guide to Retirement Planning (9780470455579): Taylor Larimore, Mel Lindauer, Richard Ferri, Laura F. Dogu, John C. Bogle: Books
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Old 04-05-2011, 03:40 PM   #5
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30 year bonds could take a big big plunge should interest rates go up.

Your 30-year bond strategy is (probably) without default risk. But it is likely at big risk for losing principal and spending power when rates go up.
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Old 04-05-2011, 03:48 PM   #6
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Originally Posted by midnighter777 View Post
If I could withdrawal safely from the principal too, I would do that.
There are no guarantees in life (or retirement income). If you are that fearful that you don't want to touch your principal, you have options such as converting a portion of your portfolio to a Single Premium Immediate Annuity (SPIA), which will (under one option) provide you income for the rest of your life, with a portion of your portfolio.

Unfortunately, that's not the answer for your entire portfolio and may not make sense at all depending on your entire financial situation. Heck, I/DW have an SPIA, but I'll be the first to say it is not for everybody.

It sounds like you are a bit fearful (really, we all are but some handle it better) and a fee only planner (e.g. pay by the hour, and they have no products to sell) would work best in your case - just to sit down one-on-one to look at your situation and suggest alternatives that make sense to you...
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Old 04-05-2011, 04:07 PM   #7
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Your question covers a lot of ground. Some observations:
-- Building a total bond portfolio big enough to cover living expenses using just the interest payments is not usually practical--it would take a very big portfolio (as you point out). It would also offer no inflation protection, which is a huge problem for a payout period lasting decades.
-- Your SS and pension will come online later, so don't count them out. You have a period when you need to draw down more on your investments each month, then you can reduce this somewhat as SS and your pension start paying.
-- What many people do: Put a few years (3-5?) worth of expenses in a "cash" bucket. If the market takes a real dive you can live on this until it recovers (hopefully) and therefor not sell stocks and bonds when their prices are depressed.
-- For the rest of the portfolio, pick an allocation of domestic and foreign stocks and bonds you are comfortable with. Some folsk would add REITS and commodities into that list as well. For a long retirement, a higher % of stocks will give you the best chance of keeping up with inflation. Every year, (or if things get really out of whack with your desired allocation) rebalance the money in your categories to bring them back into alignment. You'll be selling the stuff that has gone up, and buying more of what has gone down--it's a passive way of buying high and selling low (kinda . . .). If everything has gone down, dip into the cash bucket for your annual spending money, but still rebalance your other assets.

There are many good references for withdrawal strategies. There's info on this site, and Bob Clyat's book (web site--> "Work Less, Live More" ) has a well explained startegy, etc.
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Old 04-05-2011, 05:13 PM   #8
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Read the trinity study. Do some searches searches on the forum

Read some books on retirement planning. Do some searches searches on the forum
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Old 04-05-2011, 05:32 PM   #9
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Originally Posted by midnighter777 View Post
I believe that at the point of retiring, my asset allocation will need to shift, and the majority of my investments will need to be in bonds.
I don't see why. There is no reason that your need for regular monthly income has to be reflected in a portfolio that yields the monthly amount you need in interest. You could be invested entirely in a common stock mutual fund, for example, and simply instruct the fund manager to sell shares every month and send you a check for the amount you require. What does it matter to you whether your monthly income comes from bond interest or stock sales?
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Old 04-05-2011, 05:39 PM   #10
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Quote:
Originally Posted by MasterBlaster View Post
30 year bonds could take a big big plunge should interest rates go up.

Your 30-year bond strategy is (probably) without default risk. But it is likely at big risk for losing principal and spending power when rates go up.
I noticed this article today that talks about your point and some of the others in this thread.

retirement-how-long-will-money-last-cnnmoney: Personal Finance News from Yahoo! Finance

One thing it took me a long time to realize was the importance of having some "cash" type assets in my 401k far enough in advance of my retirement date so I could still retire if the market was down.
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Old 04-05-2011, 09:17 PM   #11
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Originally Posted by midnighter777 View Post
I believe that at the point of retiring, my asset allocation will need to shift, and the majority of my investments will need to be in bonds.

I know that I am leaving Social Security and a small defined benefit pension (for which I am eligible) amount out of this analysis. But I may want to retire early enough that Social Security and a defined benefit pension payment would not kick into effect for a long time (say 20 years for SS and 15 years for pension).
You should be adjusting your AA between equities and fixed income throughout your life to match your circumstances, so there's not one point where you switch into retirement income mode. If you are only a few years from ER your AA should be pretty close to what it will be at ER.

The correct AA will reflect your personal investing biases, principal amount and income requirements, but all bonds would actually be riskier and produce less return than having say 20 to 40% equities as you run the risk of inflation and missed bull equity markets eating into your returns.

I admire your goal of living entirely off returns and preserving or growing principal. However most plans will gradually eat into principal
and the trick is to make your money last until you die not knowing when that will be. However with a SPIA you give up your principal immediately in return for the assurance of lifetime income.

Finally include all your sources of income when planning, SS and pensions are sources of stable income and if you have those covering basic expenses you can be a bit more adventurous with your investing. If you have an income gap you might want to buy an SPIA with a portion of your investments to guarantee your basic requirements, or you might use a combo of dividend paying stocks, bond funds and a cash bucket if you want to have access to your principal and manage things yourself.
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Old 04-05-2011, 10:57 PM   #12
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I have certainly been researching this topic as I will soon be ready to live on my portfolio's earnings. For the first few years, my goal is to not withdraw any principle at all. I'm using a mix of textbook strategies. One is the Total Return Strategy, in which I'll keep my AA at 50-60% equities, 30-40% bonds and about 5-10% cash. With this strategy you withdraw annually from the class that has gone up the most to feed your living expenses for the following year (or two). If none have increased, you can continue to live on the cash portion of the portfolio until one of the classes recovers. Worst case, you need to pull as small amounts as possible in down markets. If this happens, I'll cut my discretionary expenses.

Added to this, I will build some bond ladders so I have one or more bonds maturing every year, from which I can either reinvest the bond, or pull some, or all, of it out for living expenses.

I just have not warmed up to SPIA's. At my age, the payout is only about 5% with no inflation adjusment - and I'm giving up all of the principle. Can't figure out the benefit of that, at least not until I'm older.
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Old 04-05-2011, 11:08 PM   #13
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I'm using an essentially all equities portfolio for retirement, using the "total return" approach. I sell equities as needed to meet expenses, yet under reasonable circumstances and withdrawal rates the portfolio value will still increase faster than inflation. This is slightly more work than letting dividends or interest payments stream into your checking account, but should provide the best growth/income over time.

That said, I do try to collect cash (sell) when the portfolio is doing better than expected and use it up when the portfolio is not doing so well. Before I retired I held about three years of expenses in cash. I'm just about back to that point now.
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Old 04-06-2011, 10:27 AM   #14
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I'm using an essentially all equities portfolio for retirement, using the "total return" approach. I sell equities as needed to meet expenses, yet under reasonable circumstances and withdrawal rates the portfolio value will still increase faster than inflation. This is slightly more work than letting dividends or interest payments stream into your checking account, but should provide the best growth/income over time.
I won't debate you, since that is what I did over the first three years of retirement. There always was a debate of total return vs. dividend income.

However, over the past year I did change my method of accumulation of cash for retirement expenses. That included the direct transfer of any distributions to my (TIRA) MM account, which is used to pay my retirement expenses - along with tax due on TIRA withdrawals.

I found that after three years (and deriving a good portion of retirement income from my retirement accounts) that I would constantly face the decision of if I would sell today, based upon an analysis of my purchase vs. current valuation of a fund (as you are doing, currently).

In the last year, I changed all distributions to be deposited to my TIRA MM (e.g. tax deferred). This fund is targeted to hold 3-4 years in gross retirement income (also includes taxes due) to cover those times (such as 2008) that resulted in negative returns.

I set up DW/my (even though DW has yet to retire) with enough cash to cover 3-4 years of required retirement income (included taxes due on distribution).

During down years (such as 2008) I don't add to the fund, but on "up years" or periods of gains, I'll sell off and add to cash, as I did yesterday.

Yesterday, I sold off a bit of NBGEX (Neuberger Berman Genesis Trust) with a 10.68% YTD return thus far, along with a bit of VIMAX (Vanguard Mid Capitalization Index Adm) with a 9.25% YTD yesterday, which actually will fund just under a year of gross income, which includes taxes due.

As for the OP? Maybe he can see this post and realize that he/she does not need to fear the options available. You don't need to just put your money in "safe investments", but rather become comfortable in "working your portfolio" provide a source of income, covering the down years, and accounting for possible future inflation.

Maybe the OP does not want to put their "toe in the water"; but once they do, they may find (with a little knowledge) that they can swim in retirement waters without any major impact.
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Old 04-06-2011, 12:56 PM   #15
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I found that after three years (and deriving a good portion of retirement income from my retirement accounts) that I would constantly face the decision of if I would sell today, based upon an analysis of my purchase vs. current valuation of a fund (as you are doing, currently).
I'm much more mechanical than that. I have a target allocation for each fund, so I can sell shares from funds that are above their target when I need cash. I do additional rebalancing when a fund exceeds or falls below its target by a certain percentage, without affecting cash levels. I also have a portfolio target value and will sell shares that are above their target, my contribution to that 3 years cash reserve that I spend or reinvest in down markets. No timing, no qualitative fund assesments or predictions.

Ideally I'd like to keep cash at a minimum so that I don't have 3 year's cash (12% of portfolio and 4% SWR) sitting around for all 30+ years of retirement.
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Old 04-06-2011, 01:25 PM   #16
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Ideally I'd like to keep cash at a minimum so that I don't have 3 year's cash (12% of portfolio and 4% SWR) sitting around for all 30+ years of retirement.
That's the difference in our two plans. Our current cash holdings (as a percentage of total portfolio) are much, much less. That can be attributed to either having a larger portfolio, or less retirement expenses (and need for withdrawl of cash). It can't be "framed" in one consistant manner.

The other thing to consider is the "quantity of cash" that DW/I have. While we both have established a 3-4 year target, our actual cash held is high only at this time of my retirement (DW is planning to retire sometime this year).

Why? Simply because all of our retirement income sources have yet to come "on-line".

Of the two "short term" (my DW's current income and my future claim against her SS for 3.5 years) and five "long term" (current SPIA, future SS for DW/me, and two small pensions for DW), we currently have only two sources active. Over the next 6.5 years, when all long-term sources are active, our actual cash holdings will be minimual - a fraction of what we currently have, since most of our "life income" will cover our anticipated/planned expenses at that time.

Upon analysis of our annual investment returns (since 1982) we had three years total with negative returns. Two of those years were back to back. That's why the 3+ year cash reserve seems "prudent" due to our actual history. We've planned for an additional year (50%) over the two year "failure" rate we already experienced.

You are willing to take a bit more risk by having less cash in reserve. Everybody, and every retirement income plan is different, depending on your needs, your age, and your long term "experience" in the market. As long as you have a short/long term plan that works for your situaton and you are confident in it, that's all that matters (isn't it? )...
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