What would you do? Early Retirement Strategy

[Debinnov a]

Wow, I've learned alot about bonds from my other question - thank you everyone!

If you guys were in my shoes with approximately $2M that needed to last you for 30 years (I will be 57 in a couple months and retiring), what would you do as a very conservative strategy?

We will both retire when we sell our business, (in the process) with no pension - just $500K in 401K and $1.6M regular accounts, $1900 soc sec in six years and another $1100 (todays dollars) in twelve years. Should make enough from sale of current home to just about purchase our new home in retirement community. Downsizing and will be living more simply.

I've run some different scenarios but hard to figure out what interest rate I can get. If I put in 1 - 2% interest, with inflation, we run out of money. I could see myself putting most into CD's (laddering? I need to research to see exactly how that works) and then take maybe a portion of the $$ and put into index funds of some type? (For longer term?)

I would love to hear suggestions. After owning my own business for almost three decades, I'm ready to retire - due to health and stress. It will be hard to give up the big salary, but worth it! I'm just anxious and keep running the numbers over and over - is that normal?

Thanks,
Deb

 

[Ready]

Hi Deb,

As you noted yourself, keeping money in CDs at 1-2% interest will definitely not result in having enough money to live on. As we all end up figuring out eventually, you have to take some risk to ensure that your portfolio will survive, unless you have so much money that you can truly lose money to inflation and still have enough.

If you want a conservative approach, you could invest something like 30 or 40% in equity index funds, and the rest in fixed income. You could split the fixed income between some bond funds, TIPS, and CDs. That would be a very conservative portfolio, but would still give you enough exposure to equities to keep up with inflation.

If you plug in your figures in Firecalc, with equites of 30-40%, it will give you a good idea of whether your portfolio will survive for 40+ years. Once you do that, let us know the results and we can go from there.

 

[pb4uski]

I retired at 56. My AA has been 60% stock/40% fixed income but what is best for you depends on your comfort with investing and how conservative you need to be to sleep at night. Just remember, inflation is your enemy and if your investments are too conservative then they really are risky because of inflation.

I think most people on these boards hold 40-70% in equities as a hedge against inflation.

Another important factor is how much you need to live the lifestyle you desire in retirement. To be ridiculous, if your only need $20k a year to live you could plunk the whole lot in FDIC insured CDs and enjoy retirement. If you need $60k or more then you need to take some risk.

Call Vanguard and ask them to do a financial plan for you. I suspect that they would do it for free given the potential investment, but even if you had to pay for it and got a refund once you invested with them it would be worth it.

Your new "job" is to decide how to best invest your nestegg so it grows to cover inflation and provides financial security for you and your loved ones for the rest of your life. It is not hard to do, it is a learning process and there are lots of resources to help - plus the hours are very flexible!

Congratulations!! and good luck.

 

[daylatedollarshort]

Do you have a retirement budget? How much will your annual expenses be? How long do you want to plan for?

In simplistic terms, $2M / 30 years = $60K per year, plus Social Security benefits later on.

If your expenses are low enough, you will do just fine with a very conservative portfolio. What matters most is probably your real interest rate, not the nominal rate. Real rates over the years can be found here -

Real interest rate (%) | Data | Table

You can find the rates on TIPS - treasury inflation indexed securities here -

United States Government Bonds - Bloomberg

 

[derekc]

Deb
as a very conservative strategy I would plan on 40 years, not 30. I would have 30% in stocks fund to help protect against inflation. 50% in a total bond fund(to protect against sequence of return issues; that is bad market returns in the early part of retirement), and 20% in a short term TIPS fund (again for inflation protection). At ages 72 to 77 I would start buying inflation adjusted SPIAs annuities, to protect against longevity and inflation. I would convert enough of my savings into SPIAs over that time to guarantee having enough to live on comfortably for as long as I lived (or at least up to half of my savings).
Even being conservative you should be able to withdraw 3 % pa of your savings and increase that amount by inflation each year, so that would be $60000pa. So if you think you can live on $60000pa until you get soc sec I think you will be just fine.
But do remember to work out how you will pay for long term care, either by insurance or how you will self insure. The big risks in retirement are inflation, sequence of returns, longevity, and long term care costs. Each needs to be planned for.

 

[Debinnov a]

Okay, I'm running more firecalc scenarios. It is a bit depressing. You would think that having $2M for a moderate income and wanting it to last 30 years, wouldn't be that hard and I guess it wouldn't be if I was not so risk averse.

Is it correct that under portfolio in firecalc, I choose "long interest" and then put 30% in equities? If that is the case, I get a 100% success at $83,000 spending (and that is before taxes right? because Firecalc doesn't do taxes) So I need to really rethink this - $90,000 spending was the goal.

Okay, so at this point, it looks like I need at least 30% in equities... Does it matter if it is the 401K portion or the "already taxed" portion?

You know, it is more fun running these numbers while I am still working and can add more money to the calculations when I can. But once I sell the business for a set amount and then add my savings - that is it! Unless I want to work and I don't know that I want to do that!

Thanks everyone and I can't believe how much I'm learning from this site - if only I could become more of a risk taker!

Deb

 

[Singletrack]

Deb, one thing that is unclear to me is how you are treating the proceeds from the sale of your business. I assume that this will be in addition to your current $2.1M portfolio?

 

[pb4uski]

If you want 30% equities, a good play might be to hold fixed income investments that generate taxable income in your 401k and Vanguard Wellesley in your taxable account. Wellesley is a 40/60 fund so you would have ~ 640k (40% of 1,600k) of equities or 32% of your total 2,000k nestegg. Personally, I think that is too conservative and you should consider Wellington which is 60/40 rather than Wellesley which would put you with ~48% equities overall.

Actually taxes is another reason to increase your equities. If your income is in the 15% tax bracket (72k of taxable income for a couple), qualified dividends and long-term capital gains are tax free but non-qualified dividends are taxed at ordinary rates. So as an example, if you owned 1,600k of Wellington and it paid 2.5% in dividends (40k) then ~60% of the dividends would be tax free whereas if it were in Wellesley then only ~40% would be tax free.

 

[Debinnov a]

Deb, one thing that is unclear to me is how you are treating the proceeds from the sale of your business. I assume that this will be in addition to your current $2.1M portfolio?

Nope, sale of business and savings will probably put me just north of $2M... of that $500K is 401K - rest is all "after tax". Sale of business in the $1.5 range so counting after capital gains and other applicable taxes.

 

[derekc]

You are right to be fairly risk adverse: any one of the financial risks in retirement I mentioned can quickly halve the value of your hard earned retirement savings that you have worked so hard to get. You do not want to see years of work decimated. The risks are real. Know them, plan for them. While stocks are seen as risky, surprisingly it has been shown that to have less than 20% in stocks/equitie is actually more risky than having 20% or more. On the other hand to have too much in stocks is a huge risk because stocks can quickly plummet in value as we have seen in recent times.
Yes it does matter where your equities/stock are held but I will leave that to those more familiar with all the issues or for your further research.

 

[IlliniProgrammer]

Hi Deb.

This kind of situation might be a good place for some sort of longevity insurance or a lifetime inflation-adjusted annuity.

I would not invest everything with one insurer.

I would not stick everything in annuities either.

I would shop for the best deal from a highly rated insurer (preferably a mutual). Remember, this is a 40-year product, and you are stuck with their credit risk (although there are state insurance guarantee funds to help.)

I would wait for higher rates if I could.

I would see what terms I could get on a 6%, 10%, or unlimited inflation rider right now. Inflation protection looks cheap given the TIPS spread, but no-arbitrage pricing is not always how insurance actuaries think.

But your uncertainty about your longevity could help an annuity make sense here.

 

[Katsmeow]

Okay, I'm running more firecalc scenarios. It is a bit depressing. You would think that having $2M for a moderate income and wanting it to last 30 years, wouldn't be that hard and I guess it wouldn't be if I was not so risk averse.

You are right. It's not hard. But, then there's that risk thing. I understand being risk averse. I am risk averse. (DH thinks I'm insanely risk averse about all kinds of things -- and he has a point).

So, as one risk averse person to another, I would like to adjust your thinking (or at least suggest a different way of thinking which you can take or leave or something in between).

It is easy to think that by having only CD's or only bonds or only any other fixed income investment you can think of - that you are lowering risk. After all with those types of vehicles your chance of losing your principal is extremely low (unless you are foolish and put all your CD's in one bank but I'm sure you wouldn't do anything like that).

What I really had to get into my head is that the risk I am really trying to avert is that of running out of money before I die or having to cut my spending to an uncomfortably low level.

When I look at it that way, it is easy for me to realize that losing my principal because of a stock market crash (I would always use index funds so I'm not worried about one company going broke) is one way of running out of enough money, but it isn't the only way of running out of enough.

You can also run out of enough money by having the real value of your money eroded by inflation so that you have to spend more than you planned and you either run out of money or you have to cut your spending to way below where you want it.

So, one way of losing money is for equities to crash and never recover (of course, historically, it always has recovered in the US). Another way of losing money is for inflation to eat away at the value of your money. It is easy to think that just a little inflation won't hurt. But, over the period of 30 or 40 years even a little inflation adds up. And, there have been times that inflation has been high.

The way I see it is this:

1. The chance of my money losing value through inflation over many years is almost 100% if I have no equities. It is a gentle loss at first, but it can't be stopped and it continues on. Now, if I had $2 million and thought I could live on $40k a year, and I was going to collect SS, then I might not care. I might figure that my money could lose half its value and I would still have enough.

2. The chance of my permanently losing a significant part of my money through a massive crash of all equities seems much smaller. The risk of that occurring just doesn't seem likely. Chance that equities will have a severe drop (40%, 50%), but would recover over time, seems very possible. However, the recover over time is really important here. It was scary when we had that unpleasantness a few years ago and equities went down significantly. But we didn't panic and we didn't sell at the bottom so it worked out fine.

Now, granted, it could be different some day. Equities could crash and never come back. I would suggest that if that happened there would be a lot of problems such that I'm not sure owning a bunch of CD's would necessarily make everything OK.

Another real risk is having a sustained bear market early in retirement (look up sequence of returns) causing the portfolio to need to go down at a time you have to withdraw living expenses from it. If severe enough the portfolio might not be able to survive. When we ran Firecalc and were getting success rates of 95%, this type of thing was usually the culprit.

However, if you know you have that risk you can do things to try to ameliorate that possibility.

The point is that for me I felt that having a no equities portfolio was way more risky than having a portfolio with equities.

 

[Dwhit]

With 2 million you get an $80,000 withdrawal with a 4% withdrawal rate. When I ran Firecalc it gave a 95% success rate with a 60% stock ratio. Add in the social security and I think you should be quite confident. I am looking to Fire very soon, and I am planning on a 60/30/10 equity/bond/cash split (or close to it). You may want play with adding the SS to see if you can get to $90,000 withdrawal.

While my numbers are a little different from yours, I think using a 4% AWR with the 60% equities for a planned 30 year duration (with a SS adder later) is a reasonably good plan. I hope so, because that is the plan I have.

I plan to monitor it closely and adjust the withdrawals if needed. But 30 years is a long time and I think you need significant equities to fight inflation. It might help with your tax issues as well.

 

[daylatedollarshort]

If you don't have LTC insurance, you may want to set aside money from your portfolio to self insure, so that leaves even less to live on.

If you will be downsizing, have a paid for house, and plan to live more simply, do you really need $90K to live on in retirement to be happy?

If you can figure out how to cut your expenses yet live well, you can have a conservative portfolio. Figuring out how to pay zero income taxes and maxing out ACA subsidies pre-Medicare can really help your numbers, if you have not already looked at how to do that.

 

[Debinnov a]

You are right. It's not hard. But, then there's that risk thing. I understand being risk averse. I am risk averse. (DH thinks I'm insanely risk averse about all kinds of things -- and he has a point).

So, as one risk averse person to another, I would like to adjust your thinking (or at least suggest a different way of thinking which you can take or leave or something in between).

It is easy to think that by having only CD's or only bonds or only any other fixed income investment you can think of - that you are lowering risk. After all with those types of vehicles your chance of losing your principal is extremely low (unless you are foolish and put all your CD's in one bank but I'm sure you wouldn't do anything like that).

What I really had to get into my head is that the risk I am really trying to avert is that of running out of money before I die or having to cut my spending to an uncomfortably low level.

When I look at it that way, it is easy for me to realize that losing my principal because of a stock market crash (I would always use index funds so I'm not worried about one company going broke) is one way of running out of enough money, but it isn't the only way of running out of enough.

You can also run out of enough money by having the real value of your money eroded by inflation so that you have to spend more than you planned and you either run out of money or you have to cut your spending to way below where you want it.

So, one way of losing money is for equities to crash and never recover (of course, historically, it always has recovered in the US). Another way of losing money is for inflation to eat away at the value of your money. It is easy to think that just a little inflation won't hurt. But, over the period of 30 or 40 years even a little inflation adds up. And, there have been times that inflation has been high.

The way I see it is this:

1. The chance of my money losing value through inflation over many years is almost 100% if I have no equities. It is a gentle loss at first, but it can't be stopped and it continues on. Now, if I had $2 million and thought I could live on $40k a year, and I was going to collect SS, then I might not care. I might figure that my money could lose half its value and I would still have enough.

2. The chance of my permanently losing a significant part of my money through a massive crash of all equities seems much smaller. The risk of that occurring just doesn't seem likely. Chance that equities will have a severe drop (40%, 50%), but would recover over time, seems very possible. However, the recover over time is really important here. It was scary when we had that unpleasantness a few years ago and equities went down significantly. But we didn't panic and we didn't sell at the bottom so it worked out fine.

Now, granted, it could be different some day. Equities could crash and never come back. I would suggest that if that happened there would be a lot of problems such that I'm not sure owning a bunch of CD's would necessarily make everything OK.

Another real risk is having a sustained bear market early in retirement (look up sequence of returns) causing the portfolio to need to go down at a time you have to withdraw living expenses from it. If severe enough the portfolio might not be able to survive. When we ran Firecalc and were getting success rates of 95%, this type of thing was usually the culprit.

However, if you know you have that risk you can do things to try to ameliorate that possibility.

The point is that for me I felt that having a no equities portfolio was way more risky than having a portfolio with equities.

Thanks for the great explanation! I know that everyone is right about that and I will definitely have at least probably 30% or 40% in some sort of equity funds.. Do stock index funds count as equities or are they too "tame"?

 

[Debinnov a]

If you will be downsizing, have a paid for house, and plan to live more simply, do you really need $90K to live on in retirement to be happy?

Well the $90K spending is pretax, correct? So if I have $2M and $500K of that will be taxed (401K) and the rest is tax free withdrawals - and then social security will come a few years down the road which will be taxed, what would you use as the tax percentage to use in the scenarios? I usually put in 20% to be safe but if alot of the withdrawals have already been taxed, can I lower that 20%? To what number?

Deb

 

[HFWR]

Stock funds are just "equities" held in kind by all buyers of the fund. Index funds, which attempt to track an index, like the S&P 500, are a good way to diversify among many stocks, and if chosen carefully, at low cost.

 

[imoldernu]

This veers from your investment discussion, but as I look at your planning at age 57, and see the "income needed"... I wonder if you might consider if those same "needs" will be there over the next 35 years...
In my own case, though we are in vastly different income brackets, current experience at age 78 is that my current and future needs have changed, reducing my previous budget (in the more active years of retirement) by 30% to 40%... This has changed my previous plan from even $ needs over the full retirement period, to what I call "Phase II... projecting lower basic expenses as DW and I slow down, reduce expenses by selling our senior community home in Florida, and a local "camp"... to a less expensive existence, in a continuous care retirement community.

Post # 115 in this link explains a little better.
http://www.early-retirement.org/forums/f27/sharing-23-years-of-frugal-retirement-62251-2.html

I don't see a problem with your plans, either way, but you might consider Phase II as a bonus back up.
Best of Luck

 

[Debinnov a]

This veers from your investment discussion, but as I look at your planning at age 57, and see the "income needed"... I wonder if you might consider if those same "needs" will be there over the next 35 years...
In my own case, though we are in vastly different income brackets, current experience at age 78 is that my current and future needs have changed, reducing my previous budget (in the more active years of retirement) by 30% to 40%... This has changed my previous plan from even $ needs over the full retirement period, to what I call "Phase II... projecting lower basic expenses as DW and I slow down, reduce expenses by selling our senior community home in Florida, and a local "camp"... to a less expensive existence, in a continuous care retirement community.

Post # 115 in this link explains a little better.
http://www.early-retirement.org/forums/f27/sharing-23-years-of-frugal-retirement-62251-2.html

I don't see a problem with your plans, either way, but you might consider Phase II as a bonus back up.
Best of Luck

Yes, I've been thinking the same thing. I can't imagine we will need quite as much after age 75 (possibly before) so I'm going to play with the calculators!

Thanks

 

[traineeinvestor]

Thanks for the great explanation! I know that everyone is right about that and I will definitely have at least probably 30% or 40% in some sort of equity funds.. Do stock index funds count as equities or are they too "tame"?

Definitely equities. Low cost passive/index funds are generally preferred.

 

[traineeinvestor]

The point is that for me I felt that having a no equities portfolio was way more risky than having a portfolio with equities.

+ 1

I lose more sleep worrying about inflation than I do worrying about market volatility (with the caveat that inflation is generally higher where I live than in the US and I am planning for the money to last 50 years).

For that reason, most of our savings are either in real estate or equities.

 

[daylatedollarshort]

Well the $90K spending is pretax, correct? So if I have $2M and $500K of that will be taxed (401K) and the rest is tax free withdrawals - and then social security will come a few years down the road which will be taxed, what would you use as the tax percentage to use in the scenarios? I usually put in 20% to be safe but if alot of the withdrawals have already been taxed, can I lower that 20%? To what number?

Deb

How low you can go depends on your individual tax situation, but there are many threads here and other ER forums on how to pay zero taxes in ER and semi-ER.

I don't know the exact number for other households, but the number I see kicked around is that many households with a taxable income of $50K or less will not pay any federal income tax at that level because of tax credits, exemptions and deductions available to the middle class and below. Add in capital gains and Roth strategies, and that can help, too.

$90K - $20K in ACA subsidies - $18K in state and federal income taxes = $52K left over. So if you can figure out how to get your MAGI low enough to not pay much if any in income taxes or much in your portion of health care premiums, you don't end up with that much difference in leftover spendable income than if you start with a much higher MAGI and don't do any tax or ACA planning.

Most posters here are Boglehead followers and are big on equities and mutual funds, and are looking for higher returns on their portfolios than I am willing to settle for. I have been more influenced by Zvi Bodie, who more a fan of TIPS and I bonds for inflation protection -

http://www.zvibodie.com/

Added -

There is a good, short summary of his investing style here -

http://www.aarp.org/money/budgeting-saving/info-05-2013/safest-investment-path-for-retirement.html

 

[seraphim]

Just for starters, Vanguard has been mentioned several times; their managed funds Wellington and Wellesly, but also their total stock and bond funds. Our retirement portfolio is 60% equities, in Vanguard funds (vTSAX and VTIAX international). They are inexpensive, we'll diversified, and take no maintenance other than occasionally rebalancing. Look into them.

Also look to Morningstar.com for a free account. They don't sell stocks and bonds - only data - but the free account provides tons of information, tools and they have a free classroom which walks you through stocks bonds and funds in short five minute online tutorials. It gets as advanced as you want it to be.

Just a couple of thoughts. Welcome to the club.

 

[robnplunder]

I'd keep between 30 - 50% of my asset in equities to protect my investment but still beat inflation. That will give me more spending budget and live a little in my retirement.

 

[Katsmeow]

Thanks for the great explanation! I know that everyone is right about that and I will definitely have at least probably 30% or 40% in some sort of equity funds.. Do stock index funds count as equities or are they too "tame"?

Stock index funds definitely count as equities. Many people have all their equities in index funds. I have the vast majority in index funds but do have a relatively small part of our portfolio in Wellesley which is a managed fund, that has about 1/3 equities in it.