Ready to build an Income Plan

[TNBigfoot]

OK...I've run Firecalc and (multiple other planners for FIRE @60) with
100% success. So I'm trying to wrap around an income plan that protects against inflation, sequence of returns risk.

What strategies are you looking at or are having success with. I like the idea of guaranteed income streams for the first 8-10 yrs before delayed SS kicks in. However this is a major drawdown of funds up front.

Appreciate your experience and insights.

 

[pb4uski]

I looked at buckets at one point and at the end of the day it just brings you back to 60/40 or something similar. Think of it this way... if your WR is 3.5% and your AA is 60/35/5, then you have ~18 months in a cash bucket and 10 years+ in bonds.

Hence, I take a total return approach... withdrawals come out of cash and I replenish cash when I rebalance. No need to make it more complicated.

 

[TNBigfoot]

Like your thoughts pb4uski. How do you view sequence of return risk if there is a major market correction? Do you have any protection?

Maybe I'm making this too hard.

 

[jzajzz]

Like your thoughts pb4uski. How do you view sequence of return risk if there is a major market correction? Do you have any protection?

Maybe I'm making this too hard.

I think the hope is that 3.5% WR is conservative enough that it gives your plan time to catch up at a decent rate when the marke is up.. hopefully the market correction doesn't happen in the early years.

 

[pb4uski]

I think you probably are making it too hard.

Let's say we have a 15% contraction that lasts 4 years and then comes back and let's say today I have $1,000,000 that is 60/40 and my WR is 3.5%, or $35k a year. To make the numbers simple, I assume no income and level withdrawals... just a 15% dive in year 1 and a 15% recovery in year 4, $35k withdrawals each year and annual rebalancing.

0 At inception: $600,000 in stocks, $400,000 in bonds, $1,000,000 total 60/40 AA
One year later: $510,000 in stocks, $365,000 in bonds, $875,000 total 58/42 AA
1 After rebalancing: $525,000 in stocks, $350,000 in bonds, $875,000 total 60/40 AA
Another year later: $525,000 in stocks, $315,000 in bonds, $840,000 total 63/37 AA
2 After rebalancing: $504,000 in stocks, $336,000 in bonds, $840,000 total 60/40 AA
Another year later: $504,000 in stocks, $301,000 in bonds, $805,000 total 63/37 AA
3 After rebalancing: $483,000 in stocks, $322,000 in bonds, $805,000 total 60/40 AA
Recovery year: $555,000 in stocks, $287,000 in bonds, $842,000 total 66/34 AA
4 After rebalancing: $505,000 in stocks, $337,000 in bonds, $842,000 total 60/40 AA

OTOH, if there was no downturn and no recovery after 4 years of withdrawals one would have $860,000 ($1,000,000 - $35 * 4 years), only $18,000 more than the downturn/recovery alternative. $842,000 is only 2.1% less than the $860,000, so no biggie.

 

[Al18]

I'm planning on retiring next year. My AA is 55/23/22. The 22% cash is built with multiple 5, 7 and 10 year CD's that are maturing within the next 7 years. In a significantly down market, I'll be mostly living off the CD's. In a neutral or up market, will be spending off all asset classes.

Note about 1/2 of my income is a NON cola pension.

 

[nun]

Like your thoughts pb4uski. How do you view sequence of return risk if there is a major market correction? Do you have any protection?

Maybe I'm making this too hard.

You can set up your AA to mitigate sequence of return risk by having a cash allocation.

Prior to my pension starting I put 10% of my assets into a stable value fund. The idea was that if there was a crash I'd be able to live off that cash until the market came back. Also, if you can get a good portion of your income from dividends and interest you won't have to sell at a loss.

Of course if you want a guarantee there's always an SPIA.

 

[mrfeh]

Like your thoughts pb4uski. How do you view sequence of return risk if there is a major market correction? Do you have any protection?

I also follow what pb4uski described - total return. With one exception - I have 3 years of expenses in taxable, short term holdings for use if a bear market occurs (bad sequence of returns). The purpose is to avoid depletion of equities in taxable accounts.

Now, I am 10 years younger than you. At 60, you have access to your retirement accounts already, so this is likely not necessary.

 

[Golden sunsets]

I'm planning on retiring next year. My AA is 55/23/22. The 22% cash is built with multiple 5, 7 and 10 year CD's that are maturing within the next 7 years. In a significantly down market, I'll be mostly living off the CD's. In a neutral or up market, will be spending off all asset classes.

Note about 1/2 of my income is a NON cola pension.

I would not include 5, 7 and 10 year CD's in Cash, but slot them into FI. Two years or less is reasonable for inclusion in cash.

 

[pb4uski]

While I agree that CDs longer than a year are typically not considered cash, they have a lot of attributes similar to cash... no credit risk, no interest rate risk (for bank CDs), some inflation risk... however, you can redeem most long bank CDs early for 6 months or 1 year's interest... so while technically not cash they are pretty close.

 

[rayvt]

You can set up your AA to mitigate sequence of return risk by having a cash allocation.

Prior to my pension starting I put 10% of my assets into a stable value fund. The idea was that if there was a crash I'd be able to live off that cash until the market came back. Also, if you can get a good portion of your income from dividends and interest you won't have to sell at a loss.

But that doesn't actually the mitigate sequence of return risk. It just shifts the SOR risk to after you've used up the cash allocated. Because at that point, you are starting all over again with $0 of cash.

Michael Kitces wrote an article about this. The optimum is to pick your asset allocation and stick to it. When you rebalance, just rebalance back to your chosen AA.

If you want to go 60/40, stick to that. If you want to go 50/33/17 (17% cash) then stick to that.
If you go 50/33/17 and then spend the cash (in a down market) you are effectively INCREASING your stock allocation. and REDUCING your cash allocation.

 

[jazz4cash]

I would not include 5, 7 and 10 year CD's in Cash, but slot them into FI. Two years or less is reasonable for inclusion in cash.

This is what I do also. Even though CDs share characteristics of cash, I don't like bonds right now so the longer maturities are bond substitutes.

 

[audreyh1]

I see comments about no point in having cash outside of your AA portfolio, as things are optimal to just rebalance the AA, etc. But folks have to specify what, specifically, is optimal. Yes, you maximize your long-term returns by keeping cash to a minimum outside of your portfolio, and relying on rebalancing to fund annual needs without tapping into reduced equities.

But what if the long-term return is not what you are trying to optimize? Once someone is retired, they may care more about short-term issues such as volatility of their portfolio as opposed to having a larger remaining portfolio when they die. It really depends on the individual and their circumstances - whether they have heirs they want to pass a big terminal portfolio to, or whether they have income from guaranteed sources covering most or all of their annual income needs.

Or, as in my case (no children, no other income streams), what if my retirement portfolio is already big enough? Why would I keep reinvesting excess cash into the retirement portfolio and subject it to volatility of an AA ~55% equities if the portfolio is already quite a bit bigger than I need to fund current living expenses? Especially with bonds and stocks at high valuations like they are today. My philosophy of letting cash build outside the portfolio in short-term funds is because I simply do not need to reinvest that cash for the long-term. Thus is it available today or in the near future to spend however I care to, including to help bridge reduced income if the retirement portfolio takes a big whack for a few years.

I don't think anybody here really talks about their retirement portfolio invested in some AA as being "big enough". Perhaps I am unique in this modified "won the game" perspective.

I just think that if you speak about "optimal" you need to be clear about what exactly you are optimizing. Because for some retirees that may not match their goals. There is no one size fits all here.

 

[Rustic23]

Our's is 'big enough'. I tell the kids 'We are spending your money'

 

[Nature Lover]

OK...I've run Firecalc and (multiple other planners for FIRE @60) with 100% success. So I'm trying to wrap around an income plan that protects against inflation, sequence of returns risk.

What strategies are you looking at or are having success with. I like the idea of guaranteed income streams for the first 8-10 yrs before delayed SS kicks in. However this is a major drawdown of funds up front.

Appreciate your experience and insights.

I tend to agree with what recent posts suggest...you don't actually protect against inflation and bad sequence of returns. Instead you make sure you have enough and hold what you have in an AA that you are comfortable holding.

Whether you have enough is, of course, dictated in part by how much you plan to spend and how much flexibility is in that planned spend. All the bucket, rebalancing, SPIA or other approaches won't change the fact that we're all exposed to inflation and sequence of return risks. What the approaches do is to help us define a plan to best manage through whatever actually happens. Seems like a fine point, I know; but it's an important distinction in perspective.

As for my approach: I have COLA pension income that helps, I rebalance my portfolio when appropriate, and I keep a healthy amount of cash in the bank. I also have a non-discretionary spending level that is well within my income. (I've been told that I live a "spartan" lifestyle , although to me it's luxurious.)

Certainly, any analysis would find my financial position conservative compared to some, and I won't die with the largest estate; but I believe how I've organized things leaves me with a variety of options as to how to manage through whatever happens over the next up to 35-40 years...and I like having options.

NL

 

[kimcdougc]

Our's is 'big enough'. I tell the kids 'We are spending your money'

Ahh, but the truth is that it is your money, not theirs. lol

 

[Live And Learn]

I think you probably are making it too hard.

Let's say we have a 15% contraction that lasts 4 years and then comes back and let's say today I have $1,000,000 that is 60/40 and my WR is 3.5%, or $35k a year. To make the numbers simple, I assume no income and level withdrawals... just a 15% dive in year 1 and a 15% recovery in year 4, $35k withdrawals each year and annual rebalancing.

0 At inception: $600,000 in stocks, $400,000 in bonds, $1,000,000 total 60/40 AA
One year later: $510,000 in stocks, $365,000 in bonds, $875,000 total 58/42 AA
1 After rebalancing: $525,000 in stocks, $350,000 in bonds, $875,000 total 60/40 AA
Another year later: $525,000 in stocks, $315,000 in bonds, $840,000 total 63/37 AA
2 After rebalancing: $504,000 in stocks, $336,000 in bonds, $840,000 total 60/40 AA
Another year later: $504,000 in stocks, $301,000 in bonds, $805,000 total 63/37 AA
3 After rebalancing: $483,000 in stocks, $322,000 in bonds, $805,000 total 60/40 AA
Recovery year: $555,000 in stocks, $287,000 in bonds, $842,000 total 66/34 AA
4 After rebalancing: $505,000 in stocks, $337,000 in bonds, $842,000 total 60/40 AA

OTOH, if there was no downturn and no recovery after 4 years of withdrawals one would have $860,000 ($1,000,000 - $35 * 4 years), only $18,000 more than the downturn/recovery alternative. $842,000 is only 2.1% less than the $860,000, so no biggie.

^ What he said ! (this is what I plan to do also, but this post made it much easier for me to "see" it - thank you pb4uski)

 

[rayvt]

I see comments about no point in having cash outside of your AA portfolio, as things are optimal to just rebalance the AA, etc. But folks have to specify what, specifically, is optimal. Yes, you maximize your long-term returns by keeping cash to a minimum outside of your portfolio, and relying on rebalancing to fund annual needs without tapping into reduced equities.

The point is not what you choose to specify as "optimal", since different people may well have different definitions.

The point is that whatever you define as optimal, having a significant cash bucket doesn't make your portfolio more optimal, it actually makes it less optimal. Long term, of course -- which is what matters.

As long as the definition of optimal isn't something like "gets me through the next 5 years and I don't care if everything goes to hell at year 6."

I would encourage you to download my cashbucket spreadsheet and explore the settings to see how different variations of cash bucket would have worked historically, and see if the overall portfolio would have been more optimal (for however you choose to define optimal).
https://www.dropbox.com/s/xf4ma5blug27aws/SPY_Withdraw_by_CashBucket_rules.xls

 

[audreyh1]

The point is that whatever you define as optimal, having a significant cash bucket doesn't make your portfolio more optimal, it actually makes it less optimal. Long term, of course -- which is what matters.

No, long term is not the only thing that matters to all retirees.

Just because someone doesn't maximize their assets invested for the long term doesn't mean they are going to run out of money long-term. It's perfectly reasonable to give up some long term gain for short-term liquidity or stability. It's not an all or nothing deal. It's perfectly reasonable for a retiree to decide they have enough invested to cover their long term needs, and do something else with their remaining assets, including investing them in short-term funds if they so choose.

 

[Independent]

OK...I've run Firecalc and (multiple other planners for FIRE @60) with
100% success. So I'm trying to wrap around an income plan that protects against inflation, sequence of returns risk.

What strategies are you looking at or are having success with. I like the idea of guaranteed income streams for the first 8-10 yrs before delayed SS kicks in. However this is a major drawdown of funds up front.

Appreciate your experience and insights.

Yes, that is a major drawdown of funds up front. It's more psychological than economic. If you don't want the drawdown, take SS at 62 and live with the slightly greater risk of outliving your assets (another psychological issue).



I set aside dedicated funds - CDs and I-bonds, to cover that drawdown. Note that the "income stream" here is really "spend all the principal in this dedicated portfolio". That reduced the early sequence of returns risk (at least mentally, someone else may point out that I had no more risk with everything in a single portofolio with rebalancing. I should check FIREcalc on that.)

 

[bmcgonig]

^ What he said ! (this is what I plan to do also, but this post made it much easier for me to "see" it - thank you pb4uski)

It's actually even better than pb's good example suggests if we're assuming that the market "comes back to where it was" as the 15% increase to 550 should actually be a 17.6%. (15% down needs 17.6 to get back even).

You're getting dinged on both times you sold stocks i.e., 42k. You really end up losing 15% of that, about 6k. If my math/logic is correct.

If you had a heloc you could probably borrow that 42k for less than that.

 

[audreyh1]

15% is just a normal, healthy equity market correction. It's those 50% equity hits you need to live through, that can last for many years when withdrawing and with inflation taken into account. You need to look at past history to see how bad it can get. 1966 is a pretty illustrative (eye opening) run. And there are even worse runs pre-1920.

 

[Rustic23]

The 'We are spending your money" came about because they always wanted to pick up the check. When I told them I was spending their siblings money, they said go for it!

They tell us to go ahead and spend it, and we do.

 

[aida2003]

I think you probably are making it too hard.

Let's say we have a 15% contraction that lasts 4 years and then comes back and let's say today I have $1,000,000 that is 60/40 and my WR is 3.5%, or $35k a year. To make the numbers simple, I assume no income and level withdrawals... just a 15% dive in year 1 and a 15% recovery in year 4, $35k withdrawals each year and annual rebalancing.

0 At inception: $600,000 in stocks, $400,000 in bonds, $1,000,000 total 60/40 AA
One year later: $510,000 in stocks, $365,000 in bonds, $875,000 total 58/42 AA
1 After rebalancing: $525,000 in stocks, $350,000 in bonds, $875,000 total 60/40 AA
Another year later: $525,000 in stocks, $315,000 in bonds, $840,000 total 63/37 AA
2 After rebalancing: $504,000 in stocks, $336,000 in bonds, $840,000 total 60/40 AA
Another year later: $504,000 in stocks, $301,000 in bonds, $805,000 total 63/37 AA
3 After rebalancing: $483,000 in stocks, $322,000 in bonds, $805,000 total 60/40 AA
Recovery year: $555,000 in stocks, $287,000 in bonds, $842,000 total 66/34 AA
4 After rebalancing: $505,000 in stocks, $337,000 in bonds, $842,000 total 60/40 AA

OTOH, if there was no downturn and no recovery after 4 years of withdrawals one would have $860,000 ($1,000,000 - $35 * 4 years), only $18,000 more than the downturn/recovery alternative. $842,000 is only 2.1% less than the $860,000, so no biggie.

How does it work in this scenario? Do you withdraw $35k during a 'rebalancing' session? If so, do you sell some of equity funds and some of bond funds and divert $35k to your checking account or do you sell just bond funds?

Since we're still years away from retirement, I haven't tried to visualize how TR strategy and withdrawals work? Wouldn't you keep some cash as an ER or do you strictly believe it's workable to have 60/40 AA only and no cash whatsoever?
Now, if somebody retired in 2007, the end balance would be totally different, no? The big variable would've been the reigning of emotions, IMO.

 

[pb4uski]

Different people take different approaches. Some people set up automatic withdrawals from one or more funds, some do a one-time annual withdrawal when they rebalance, and others have a modest allocation to cash and use that for living expenses and replenish it when they rebalance. All have a similar effect at the end of the day.

I do the latter... my AA includes a 5% allocation to cash and I have a monthly transfer to our local bank account that I use to pay my bills. I replenish the cash when I rebalance.