Need Help With Withdrawal Strategy

[Bob Smith]

I need some help from some of you who have already put an early retirement plan into motion. I'm having trouble visualizing the mechanics of withdrawing assets - what to withdraw first, what should be in taxable accounts, etc. I'm 51 and will quit working in one year. I plan to withdraw 3.8% in the first year and the same amount, plus inflation, in subsequent years. My portfolio will consist of roughly 50% TIPS, 40% Vanguard Total Stock Market Fund, and 10% cash. I'll re-balance annually. What's the best strategy to withdraw assets? The TIPS and stock dividends won't be enough, so I will need to sell securities as I go - but how do I determine what to sell? If someone could point me to a good book, or better yet, to software that will do the job, I'd greatly appreciate it. Thanks.

 

[unclemick]

Take your 3.8% out of cash and then reestablish your portfolio asset allocation.

Beyond that, it can get much more complicated - your tax rate, Roth and traditional IRA, 401k, any future pension kicking in, ss someday, etc.

BTY - I don't do this myself, we use Vanguard Lifestragety moderate and conservative funds to get roughly 50/50 stocks/bonds in our IRA's. Vanguard's computer's rebalance just fine-continuously- even while I sleep.

 

[Mr._johngalt]

And I rebalance myself when I decide as I don't trust others to do it. No one is more motivated investing my
money than I am.

 

[Ted]

I would say that your overall asset allocation is fine. In general, a good way to maintain it is to make your withdrawals from whatever asset class is performing the best, which right now is stocks. I must admit, however, that the prospects for stocks look so good right now, that I'd spend down some of the cash unless you are planning to use it for a big purchase.

The way that I generally approach "cash equivalents" is to maintain just enough to cover expected large purchases or unexpected emergencies, without regard to what percentage of my total portfolio this might be. Typically, I'd have $10,000 to $15,000 in "cash," most of it actually in Vanguard's short term corporate bond fund.

 

[unclemick]

That's my problem - I was overmotivated ('fear and greed') from 1966 -1994. After reading Bogle's 1994 book and reviewing my track record, I let the Vanguard computers do it - as long as there is electricity in Valley Forge.

 

[Cut-Throat]

unclemick,

What are the expense fees of these Vanguard Life Funds? Thanks

 

[unclemick]

0.27 CONSERVATIVE AND 0.28 MODERATE

 

[unclemick]

bty - 0.27 &0.28/$100 from my latest Forbes magazine.

 

[Bob Smith]

Thanks very much for the help. I have a couple of follow-up questions. In case it helps, here's my situation: I'm 51 and will retire at 52. Our total income will be around $45,000 per year in today's dollars, and I'll withdraw 3.8% from my portfolio (about $21,000 per year). The rest will come from part time work, pension, and SS. I used a spreadsheet to enter the cash flows (obtained here: http://www.portfoliosurvival.com/ ) and it all seems to work well. Here are my questions:

1. What withdrawal method is employed in the FIRECalc/Retire Early Homepage spreadsheets? In other words, assuming the allocation did not change in the course of a year (each asset gained an equal amount), do those spreadsheets assume one will withdraw from each asset according to the percentage allocated? If I'm going to proceed on the basis of the worst case scenario per those spreadsheets, I don't want to initiate a withdrawal procedure that is different than the one they use.

2. I'm planning to use TIPS simply because they produce a better historical worst case outcome than other fixed income asset classes. I don't know what the future will bring, but there's some comfort in knowing I'm planning for the worst that has occurred to date. I don't own TIPS yet - my fixed income assets are in Vanguard's Total Bond Index fund. Is anyone using TIPS? I'd appreciate opinions about this. I'm concerned that interest rates are so low now that it may be the worst time to plunge half my assets into them. But since I'm already in the bond market, it shouldn't really matter, correct? Since interest rates are so low, should I go with newly issued 10 year TIPS through Treasury Direct? Or should I by 30 year TIPS on the secondary market for the higher yield and to lock in my returns for the next 25 years or so? Or half and half? Any thoughts would be appreciated. I simply want my assets to last as long as my wife and I do. Thanks.

 

[Bob Smith]

Thanks very much for the help. I have a couple of follow-up questions. In case it helps, here's my situation: I'm 51 and will retire at 52. Our total income will be around $45,000 per year in today's dollars, and I'll withdraw 3.8% from my portfolio (about $21,000 per year). The rest will come from part time work, pension, and SS. I used a spreadsheet to enter the cash flows (obtained here: http://www.portfoliosurvival.com/ ) and it all seems to work well. Here are my questions:

1. What withdrawal method is employed in the FIRECalc/Retire Early Homepage spreadsheets? In other words, assuming the allocation did not change in the course of a year (each asset gained an equal amount), do those spreadsheets assume one will withdraw from each asset according to the percentage allocated? If I'm going to proceed on the basis of the worst case scenario per those spreadsheets, I don't want to initiate a withdrawal procedure that is different than the one they use.

2. I'm planning to use TIPS simply because they produce a better historical worst case outcome than other fixed income asset classes. I don't know what the future will bring, but there's some comfort in knowing I'm planning for the worst that has occurred to date. I don't own TIPS yet - my fixed income assets are in Vanguard's Total Bond Index fund. Is anyone using TIPS? I'd appreciate opinions about this. I'm concerned that interest rates are so low now that it may be the worst time to plunge half my assets into them. But since I'm already in the bond market, it shouldn't really matter, correct? Since interest rates are so low, should I go with newly issued 10 year TIPS through Treasury Direct? Or should I by 30 year TIPS on the secondary market for the higher yield and to lock in my returns for the next 25 years or so? Or half and half? Any thoughts would be appreciated. I simply want my assets to last as long as my wife and I do. Thanks.

 

[Ted]

I'll comment on TIPs, since I have had them for about 5 years and am a big advocate of them for retired people.

Long-term interest rates have risen about 0.4% in the last couple of weeks. The rates on TIPs have risen somewhat less. The 30 year is now yielding about 2.7% over inflation and the 10 year about 2.2% over inflation.

The 0.5% additional yield on the 30 year TIPs is significant, and I'd buy some. But there is a good chance that interest rates will rise further, in which case the longer term bonds will drop more in current value (although TIPs will probably be less affected than conventional bonds because of their inflation protection).
So I'd invest perhaps 10% in long-term TIPs, put another 10% in a high yield bond fund holding mostly intermediate term high yield bonds, and for now put the rest of my bond money in Vanguard's short term corporate fund. That's much less susceptible to interest rate risk than the bond index fund.

 

[earlyout]

Bill,

congratulations on your ER. I am also 51 and retired this year.

One withdrawal strategy, mentioned elsewhere on this site is as follows:

assumes a 4% withdrawal rate and assumes a bear market lasting 3-4 years.
put 2 years of living expenses in MMF
put 2 years of living expenses in CD (1 year)
put 2 years of living expenses in 2 yr CD.
Once a year take 4% of stock portfolio and get 2 yr CD. The stock portion helps keep up with inflation, in the meantime you have a steady income plan, that addresses bear market of 4+- years.
This plan provides for liquid, safe living expenses for 5-6 years, expecting to last until market recovers. The "cash" portion provides safety from the market, while letting the stock portion accumulate (- bear market).

The "sleep" factor is important, i.e. "how much can I lose in the market and not jump ship?". For me this is about 60% stocks and 40 % cash/bonds. Knowing that you have 4-6 years "safe" money should help with the swings in the market.

Each person has their own needs to wrok out and get a plan that meets it. It is important to have a plan to avoid the market extremes and what they can do to a portfolio.

Our withdrawal % will be in the 3-4% range, with a mix of 60% stocks and 40% cash/bonds.

best wishes

earlyout

 

[Mr._johngalt]

I respect earlyout's opinions. Obviously he is a thinker.
However, I still strongly suggest "no common stocks"
and frankly do not understand why any ERs would own them. Yes, I can see the history and I understand inflation and its effects. But, what most ERs need is
predictability. Common stocks are prey to
people acting like lemmings. If you think you have a
"long term", go for it. I don't, and even if I did I would avoid common stocks like the plague.

 

[Cut-Throat]

johngalt,

While I might agree with you on no common stocks being individual stocks - I would insist on Index Mutual Fund Stocks. I do own Individual Stocks though - And I have made a lot of money and have also been burned - This is what makes you stick to the fundamentals.

Right now after the recent run-up on stocks, I have taken some profits and am now 50% in stock mutual funds and 50% in Cash equivalents. Every 500 points the Dow moves up from here I'm moving 10% into Cash. When the Dow Drops 500 points I'm moving 10% back into Stocks.

Could I survive without stocks - probably. Do I want to? No! - I want to thrive!

A little discipline and I sleep better being diversified. With no stocks - Fears of Inflation would keep me up at night.

 

[unclemick]

Where are the john greaney's of the world? - the last one I met was the norewegian widow down by the mailboxes when we got got off the grade school bus in southwest Washington - the mailman bought the stock dividend checks.

Our ER depends on balanced index mutual funds - BUT individual stocks are my drug of choice ('hobby' is the polite word). I no longer fight my ego driven desire to putz - watch the markets everyday (1965 -now). When they get too far out of hand I sell some and we spend the money.

Real estate cats and bond only's are rare breeds. We know a few (3) and one that will be probably still be dabling in RE even when he reaches rest home age - As bad with RE as I am with stocks.

 

[Ted]

I'd like to clarify what might be seen as an inconsistency.

Early on Sept. 8 I said that I normally limit my "cash equivalents" to $10,000 to $15,000. I think that the amount of cash holdings being recommended by earlyout are excessive, and in any event I can't understand why anyone would want to tie them up in CD's as opposed to a short term bond fund, which pays as much or more interest and is more liquid.

But in a later post I recommended that Bob Smith liquidate his Vanguard Total Bond Index Fund and put a large part of it into cash equivalents (specifically, a short term bond fund). The reason for this recommendation is that right now is a particularly risky time to be holding long term bonds (other than TIPs), some of which are included in the Total Bond Index Fund.

Although Bob's idea of shifting to TIPs is good, I would make the shift gradually, as with any other major reallocation of assets. When you do that, you never totally time the market wrong and hate yourself for it!

As I said, I would also put some money into a high yield bond fund. I would add that I'd also put some into an REIT fund, such that my ultimate target allocation (aside from cash equivalents) would be about 45% stocks, 10% high yield bonds, 10% REITs, and 35% TIPs. (My own allocation is actually weighted even more towards high yield bonds.)

 

[unclemick]

Hey Bob Smith
The whole trick is between your ears - took me 30 yrs to figure that out. "sleep factor" ,"no common stocks" - The idea is to figure out your groove. Have you read the homepage article on 4% withdrawal in bad times?

For instance take Ted's post - I wouldn't agree with his asset allocation for us - BUT we did buy Vanguard REIT and Hi-Yield Corporate (10.428% of ER portfolio)

And we haven't heard from the bond ladder craftsmen yet - some of the posting's under other topic's might interest you - if you want to work the yield curve.

 

[earlyout]

Bob, et al

To get an estimate of your SS $, you can go to http. ssa.gov/ and use the on-line calculator. They ask you to input this years income and then they figure increase in salary in future years. Assuming you don't work after 52, or work part-time, then click on the assumption button and then u can enter in "0" for your current income, and get a projection of your future SS $. It at least gives you an idea of the difference in SS $ working to age 62 ( or age 65) vs stop working at age 52 (or some other age).

Also, to help evaluate a lump sum vs a monthly income, or vice versa, you could go to immediateannuity.com, enter in the age, etc and get a value for a pension, social security, etc. There are other tools available, but this is a quick way for an initial assessment.

This is only one way of looking at your ER finances. Some people use SS, pensions as "bond" type investments and then use this to get to their own desired asset allocation.

Athough assets can be important consideration in retirement, cash flow (steady reliable income) determines standard of living. So those with SS, pensions, paid for homes, etc need less assets.

Just some thoughts to share, best to all in ER

earlyout

 

[Bob Smith]

Ted, thanks for the clarification. I understand what you're saying. I had been leaning in that direction anyway, and plan to move to a short term bond fund and gradually purchase TIPS.

Johngalt, I envy your position. I'm afraid I'd have to stick with the job quite a few more years to be able to afford not owning stocks. Unfortunately, I'm burned out, used up, and just sick and tired of being sick and tired. And like Cut-Throat said, the fear of inflation may keep me up at night. But if it all comes crashing down on me 20 years from now, I'll remember this conversation and wish I had done what you suggested!

Unclemick, thanks for the advice. I think I was making it too complicated. I'll find my groove - I hope. I think I can tolerate some risk - but that's easy for me to say now with a steady paycheck still coming in.

Earlyout, I copied your comments and will use some of that. It really helped me to get my mind wrapped around the big picture. I've spent quite a few years accumulating and I'm finding that the prospect of actually spending some of it is a bit frightening. Maybe that's just me.

Thanks everyone for the advice. It is extremely helpful to be able to come here and get input from people who have actually made the leap. I'm sure I'll be back with more questions. Thanks again.

 

[earlyout]

Income based retirement vs asset based retirement


Paul Farrel had an article on cbs.marketwatch about ER and offered a counter view to the asset based retirement. Asset only based view is u need > $1 million to retire, income based uses primarily income sources not assets.
Basically, he said to add up your income sources (SS, pension, paid for house, etc) to get your "income" and then use that to figure when you could retire. Its a good article to get you thinking about options.

You can access the article thru cbs marketwatch, but need to do their free sign-up. Article was posted 3/1/2002.

earlyout

 

[Mr._johngalt]

Paul Farrel sounds like he knows his subject. Re.
helpful books and articles, here is one I have not seen
mentioned; 'Cutting Loose' by Dorothy Kalins.
Copyright 1975, published by Doubleday in Canada and
Staurday Review Press in the States, it's a back to the land/back to the basics kind of book. Little financial
advice, but some good stories of folks who dumped their
upscale urban lives for a simpler existence. I read this
before I discovered Paul Terhorst. It was good entree.

 

[unclemick]

Income streams are important. I check the SEC yields of my funds to get a feel for my 'rock bottom' cash flow. That compared to our 'core' budget provides 'emotional' comfort that the basics are covered. The distance between the SEC average and 4% is sort of the fun money zone.

Scot Burns also did an article on less than million dollar portfolios but I can't remember when. Dory36's 33% thats my story sure rung a bell - because of similar examples to illustrate portfolio size(Burns) and income(dory).

 

[unclemick]

Hey GDER
Mind if I borrow your equation for my nephew's? Nice and simple - a shootable target.

 

[Ted]

This issue of "income based' retirement versus "asset based" retirement relates to the recent discussion about estimating the present worth of social security benefits. I said that I thought it was impractical to come up with a meaningful value and, more importantly, that the exercise is academic, because the thing that matters in retirement is the income stream that a person is able to sustain from all sources.

The income stream from Social Security is about the most predictable on of all. What is much more challenging is to estimate what income stream (particularly on an inflation-adjusted basis) can be generated from financial assets. That is what FIRECalc does.

It is interesting to consider that the only thing that gives financial assets value is people's expectation that they will deliver cash in the future. Even a stock that currently pays no dividends is valued (through a combination of explicit and intuitive analysis) on the basis of the present value of expected future earnings/dividends.

The main difference between "dividend paying" stocks and "speculative" stocks is that the dividend paying stocks are expected to pay out a relatively secure, but slow-growing dividend stream, whereas "speculative" stocks are expected to ultimately pay dividends that have a chance of growing to be enormous. As the time to this future payout appears to be shortening, the price of a speculative stock appreciates even if it is not yet paying any dividends. So its annual return from price appreciation may be equal to or greater than the annual return of dividend-paying stocks.

In general, the greater predictability of the total return of dividend paying stocks causes that total return to be less than that of the overall stock market. Their lower "beta" translates to lower long-term total returns.
According to financial theory, a person can achieve highest returns associated with a particular level of risk (be on the "efficient frontier") by investing in a combination of the total stock market and bonds and/or cash.

However, if a person has a fairly diverse selection of dividend-paying stocks, they can achieve pretty nearly the same results by holding a somewhat higher percentage of their assets in those stocks. Fortunately, they now will be getting a tax break on the dividends.

 

[unclemick]

Hey Ted
I agree - big bet on the efficient frontier - little bet on diversified dividend stocks. I keep Berstein's Efficent Fronter website article on terminal wealth dispersion handy to reread when the emotional tries to overwhelm the rational. The dividend yield fell below long term treasuries circa 1958. I wonder how "mr market" will price relative yields going forward given the new tax rate.