Q: Do you have any advice on how to withdraw retirement income from a portfolio that combines a total bond fund, a total stock market fund, and a money market fund? – DA via email
A: There are no easy answers to this question unless you have so much money that you don't need to ask it. But there are sensible ways to approach the problem, which I'll discuss in the next several posts.
Let’s address it as three related questions: What’s the best way to invest your portfolio in retirement? What’s a practical method for taking annual withdrawals? And how much can you withdraw every year without running out of money?
You’re definitely on the right track with a portfolio that combines stocks, bonds, and cash; and I applaud what sounds like a decision to use index mutual funds. It's smart to invest as simply and as inexpensively as you can; and there's nothing simpler or less costly than index funds.
But I think you need more than three funds. In a very basic retirement portfolio, I'd consider owning three bond funds (one very short-term fund, one intermediate-term fund, and one Treasury Inflation-Protected bond fund), and at least two stock funds (one for U.S. stocks and one for international stocks.)
The ideal retirement portfolio, which I described in a recent article for AARP Bulletin, contains about five years’ worth of living expenses in cash and very short-term bonds, with the balance divided between stocks and longer term bonds.
"Five years is roughly the length of an economic cycle," explains Harold Evensky, a Coral Gables Florida financial planner. With five years worth of living expenses in liquid investments, you minimize the risk of having to sell stocks in the middle of a bear market. Selling at a loss is a calamity for retirees, who no longer have the time or the earnings to replenish their savings. To be sure, leaving your stocks untouched for five years doesn’t guarantee that you won’t lose money – but if you do, says Evensky, it’s unlikely to be a very big loss.
Like all good rules of thumb, however, this one comes with a big caveat – a caveat that unfortunately applies to virtually every rule about investing: It doesn't work well if you don't have enough money.
Your cash and short-term bond investments shouldn’t exceed 50% of your total portfolio, says Eleanor Blayney, consumer advocate for the Certified Financial Planner Board of Standards. The reason: At least 50% of your savings have to be invested in stocks and longer-term bonds to ensure your portfolio will last as long as you do.
If five years of your living expenses equals 80% your portfolio, Blayney says, your savings alone are insufficient to cover those living expenses throughout your retirement. You’ll therefore need to supplement your annual withdrawals with income from other sources, like a part-time job, the equity in your house, and Social Security. And that, of course, is the situation in which most of us can expect to find ourselves.
In my next post, I’ll describe the best practical method I know for taking annual withdrawals from your investment portfolio.
Please send your questions to Lynn@LynnBrennersFamilyFinance.com. I'm sorry I can't respond personally to every email. Questions are only addressed online.
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