how to invest when you're retired

How to Invest When You’re Retired

Your Investing Needs Change in Retirement

The act of retiring drives key financial changes• Money stops flowing from your income to your

portfolio and starts flowing the other way.• Your investments need to cover short term costs

and preserve your long term purchasing power.• “Waiting out” a rough patch in the market or

recovering from losses both get tougher to do if you need to sell investments from your portfolio to cover your costs.

Your Objective: A Careful Balancing ActTo address those different needs, split your portfolio into three parts based on when you’ll need the money:

Short term: Cash (Easy to spend, always worth its face value.)

Mid term: Bonds(Typically better interest than

cash to help fight inflation, more certain payouts than stocks to

help preserve value.)

Long Term: Stocks(Opportunity for long term

real growth to help the portfolio maintain

purchasing power over your lifetime, but far less

certainty on any given day.)

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Reaching that Objective: A Laddered Portfolio

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Cash 6-12 months of

expenses

Bonds7-10 years of

expenses

StocksEverything else

Each part plays its role:• Stocks: Long term growth

potential, though with little short term certainty.

• Bonds: Buffer against stock volatility, convert to cash at maturity, and some income along the way.

• Cash: Spending money.

How Much Do You Need, and Why?A decent estimate is that you’ll need 25 times the amount of money you expect to withdraw from the portfolio to spend in its first year. At that level, you’re covered by the 4% Rule, a classic rule of thumb in retirement investing.

In essence, the 4% rule says that, if you:• Invest via a well structured, diversified portfolio• Withdraw up to 4% of the portfolio’s value in its first year• Increase your withdrawals every year in line with inflation

…then your money will very likely be able to last for your retirement.

http://www.fool.com/investing/general/2014/12/28/is-the-4-rule-of-retirement-still-good-advice.aspx



Matching the Theory to Real NumbersImagine a fairly typical couple approaching retirement.

• Annual household income: $53,000 (about the US median)

• They had been saving for retirement, so between no longer paying Social Security taxes and no longer saving for retirement, they think they can live comfortably on 75% of that income level, or $39,750 per year.

• They’re expecting about average Social Security benefits, based on a one-wage-earner household:• Employed spouse: $1,328/month ($15,936/year)• Spousal benefit (50%): $664/month ($7,968/year)

The portfolio needs to cover $15,846 in year 1 expenses. We’ll round up to $15,900 for this example to make the numbers easier to follow.

Other Key Assumptions for This Example

The example also assumes:• Both spouses are at their normal Social Security retirement age

• A solution to Social Security’s long-run funding problems will be found

• The couple has no extraordinary expenses or special health risks

• When one passes, the surviving spouse’s expenses will decrease by the amount of the smaller Social Security check

• Inflation will average 3% per year, about in line with longer term trends

• The needed bonds can be bought at prevailing interest rates at par value

http://www.fool.com/retirement/general/2014/11/30/dont-let-social-securitys-shortfall-ruin-your-reti.aspx

Building the Ladder

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Cash: $15,9001 Year Bond: $16,400

Stocks: $255,900

2 Year Bond: $16,9003 Year Bond: $17,400



Total Starting Value: $397,500:25 times the first year’s spendingthat the portfolio has to cover.

Important building blocks:• Cash to cover near term expenses

• Bonds that:• Mature each laddered year• Will provide the next year’s cash,

adjusted for expected inflation• Are laddered deep enough in maturity

years to absorb typical market fluctuations over time

• Stocks that:• Are enough of a presence so that in a

typical market year, some can be sold to reload the top of the bond ladder, while the rest can continue to grow

Reminder: Strong Investing Principles MatterAs a retiree, you can’t afford weak rungs in your ladder.

• Consider high quality bonds like:• US Treasury or Agency Bonds• Insured municipal bonds• A diversified mix of “A” rated or better

investment-grade corporate bonds

• Consider intelligently diversified, low-cost stock funds like:• S&P 500 or Total US market index funds• Total World or Total Developed World index funds

• Keep your cash liquid and safe: Checking, savings, or money market

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Using the Laddered Portfolio – an Ordinary Year

Cash: $15,9001 Year Bond: $16,400

Stocks: $255,900




Cash: $16,4001 Year Bond: $16,9002 Year Bond: $17,4003 Year Bond: $17,900

6 Year Bond: $19,600


Interest: $36.08

Interest: $99.71Interest: $167.04Interest: $215.69Interest: $268.25

Interest: $304.00Interest: $343.00

Dividends: $4,875.33

Spent to Cover ExpensesCash Generated: $6,219.10

Bond Yields based on US Treasuries, Stock Yields based on SPY, as of Jan. 9, 2015

Stocks: $271,254

• The starting cash gets spent to cover expenses• The bonds generate interest and get one year closer to maturity• The stocks pay dividends and have a chance to grow

Cash Generated Year 1 Starting PointPortfolio at the end of year 1, assuming 6% stock gains

Topping off the Ladder – an Ordinary Year




Stocks: $271,254Generated Cash: $6,219.10




End of Year 1 Portfolio

7 Year Bond: $20,200Stocks: $257,273.10

Start of Year 2 Portfolio

Use the cash generated by the portfolio and sell some of the stocks to buy back that 7th year of bonds in the bond ladder.

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Repeat the process every year that the stock market has about normal returns, throughout retirement.

What if the Stock Market Has a GREAT Year?




Stocks: $307,080Generated Cash: $6,219.10




End of Year 1 Portfolio(assumes 20% stock gains)


Stocks: $272,299.10Start of Year 2 Portfolio


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If stocks have a great year, sell more from the stock portfolio to add another year to the bond ladder. This increases the buffer against the next market downswing.

Another option:Add more to each of your existing bond levels & spendable cash.

This would help you protect against faster than expected inflation or see your income increase in real terms.

What if the Stock Market Has a BAD Year?




Stocks: $204,720Generated Cash: $5,000




End of Year 1 Portfolio(assumes 20% stock losses &dividends that get somewhat cut)

Stocks: $209,720Start of Year 2 Portfolio

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If stocks have a bad year, invest the cash your portfolio generated back into stocks, instead of in bonds, and let the bond ladder decrease by a year.

Important Note:Only invest money in stocks that you don’t need to spend for at least 5 years.

Starting with 1 year of cash & 7 years of bonds gives you some, but not unlimited, flexibility to let the stock market recover from a downturn.

What about the bonds?

This laddered portfolio uses bonds in a way that reduces direct exposure to the interest rate and volatility risks associated with bond investing. It still depends on the bond issuer remaining solvent.

Key ways it reduces exposure to those risks:• Interest is reinvested, rather than used for current income• Bonds are held to maturity rather than sold early• Maturing bonds become the next year’s spending cash• New bonds are bought with expected inflation in mind. The longer

term bonds are all bought to mature at higher balances so the next year’s spendable cash increases with expected inflation.

Balanced Risks -- Solid Chance of Success

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Short term: Cash

Mid term: Bonds

Long Term: Stocks

No strategy can completely eliminate all risks.

By balancing the risks of different investment classes with the short and long term needs of a retiree, this laddered approach provides a solid chance of success over a retiree’s life span.

How one Seattle couple secured a $60K Social Security bonus -- and you can too

http://www.fool.com/ecap/income_investor/loophole-retirement-report/?aid=8610&source=iiieditxt0000022

how to invest when you're retired

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