Friday, January 13, 2017

Taking the Financial Risk Out of Retirement

[Prefatory Note: This post is not intended as financial advice or advice of any kind, and should not be relied on as such. Rather, it is intended to illustrate that some people might have an alternative to staying in the stock and bond markets that they had not thought about. Put another way, while trying to time the market is generally and correctly considered a fool’s errand, getting out of the market if one can might be considered a wise and safe choice. This post sets out a scenario where that might be the case.]

Everyone has a “retirement number” whether or not they actually hit it. That number is the amount of portfolio savings you have that could produce enough income so that you can maintain your desired lifestyle without unduly reducing the principal of your total savings. Until you hit your retirement number, you likely have the need to continue saving and investing to grow your portfolio. But, should you ever hit your retirement number, unless you can see the possibility of the market returning enough on your investment to greatly boost your life-style (e.g., enable you to fly by private jet or buy a second home on Hanalei Bay), you might consider getting out of the market and eliminating market risk (both principal/default risk and interest rate risk). Here is how to do the calculation: (i) Determine the total amount you need/want to spend each year, including both necessities and taxes and luxuries (trips, gifts) and everything in between, and add a reasonable amount for unexpected expenses; (ii) add up the total amount of assured income you have from all sources, other than from your portfolio investments, including social security, pension; and (iii) subtract (ii) from (i). If that calculation produces a negative number, then you can put your entire portfolio into any FDIC-insured CDs or U.S. treasuries you want and you’re done. If that calculation produces a positive number, determine the percentage of yield you need from your portfolio to achieve that number, and then invest your portfolio in a ladder of FDIC CDs and/or U.S. treasuries sufficient to produce that yield and you’re done. While not every risk can be eliminated and some black swan events still might intrude (e.g., the planet could be rendered unlivable by virtue of nuclear war or a nuclear winter or global warming), you can now sleep at night without worry of the stock market cratering, the bond market cratering, a trade war breaking out, or a recession taking hold.

Concrete Example 1: Assume you have $3M in your portfolio and you need $100K/year for your expenses. If you have $40K in social security and pension income, you need the portfolio to yield $60K/year to maintain your budget and not reduce the principal of your portfolio. So, the $3M would need to yield 2%. You would then ladder FDIC CDs and/or U.S. treasuries to yield 2% and you’re done. If you ladder them to yield 2.5%, your portfolio actually will grow a bit. In all events, while not every risk is removed, the vagaries of the stock and bond markets no longer will concern you.

Concrete Example 2: Assume you have $3M in your portfolio and you need $60K/year for your expenses. If you have $60K or more in social security and pension income, you do not need the portfolio to yield anything to maintain your budget and not reduce the principal of your portfolio. So, you can put the $3M into any FDIC CDs and/or U.S. treasuries you want and your portfolio will continue to grow. Again, while not every risk is removed, the vagaries of the stock and bond markets no longer will concern you.

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