Our Retirement Income Approach
Building a portfolio and living off one are two different jobs. Here's how we approach the second one.
If a downturn hits and you have to sell investments to cover next month's expenses, you're selling at depressed prices, and those shares aren't there to participate in the recovery. This is what researchers call sequence-of-returns risk.
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The approaches below often answer the same question: where does your income come from in the years the market is down? Each method has its pros and cons, and there isn't a right answer. The best fit for you will depend on a variety of factors.
1. The Paycheck Reserve Approach
With the paycheck reserve approach, we set aside several years of your spending in cash and short-term, high-quality bonds, the kind that don't move much when the stock market does. The rest of your assets stay invested for growth, so that your retirement can be supported for decades to come.
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The reserve is based on the cash flows from your financial plan, which we use to calculate what the investment portfolio has to pay after Social Security, pensions, and other income. And it's not just a one-time calculation. Your life will change, and so will the money you need. So, we re-measure it every year as your plan updates.
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Who it's a good fit for:
People who want to know, in years rather than percentages, how long they could ride out a bad market without touching their growth investments.
What are the drawbacks:
Several years of spending held in bonds, which may earn less over a long rising market when compared to the same dollars held in stocks.
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2. The TIPS Bridge Ladder Approach
The Treasury Inflation Protected Securities (TIPS) bridge ladder approach can appeal to those who want more cash flow certainty in the years before guaranteed income starts to arrive. Some clients stop working well before Social Security or a pension begins, and for a household in that position, their investment portfolio will need to fund virtually every dollar of spending for years (e.g., seven to ten years). For clients in this situation, poor market returns or high inflation can create lasting damage, and a TIPS ladder can help reduce that.
With a TIPS ladder, we buy a series of inflation-protected U.S. Treasury bonds, with a target maturity for each year (i.e., "the ladder") sized to cover the upcoming year's spending. As the ladder shortens, we build the years behind it, so there's always coverage beyond the final bond, and so that you're not put into a position where you need to sell your stocks when they're down to fund your spending. The unique aspect of TIPS is that the value of these bonds also rise with inflation, so a year of spending you set aside today is still a year of spending when you get there.
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Who it's a good fit for:
Households with a long stretch before reliable income begins, and a preference for knowing the exact date each year's money arrives.
What are the drawbacks:
A large share of your portfolio may end up being held outside the stock market, which can be risky if you need the growth to make your plan work.
3. The Dynamic Spending Guardrails Approach
The third approach, dynamic spending guardrails, primarily offers retirement protection through a spending rule rather than specifically using dedicated investments to do that job. The portfolio stays invested in one of our diversified allocations, and we set guardrails around your withdrawal rate inside your financial plan.
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The general idea around this is that if the portfolio withdrawal rate rises above a defined threshold (i.e., your portfolio has declined due to bad markets and thus your withdrawal rate is higher), your spending is reduced by a set amount. If the portfolio withdrawal rate falls below another threshold (i.e., markets are doing well and you're not spending enough of it), spending can increase by a set amount. Importantly, the thresholds and the size of each adjustment are agreed on in advance rather than decided in the moment.
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While guardrails can be suitable for the right situation, the main drawback is that in a prolonged downturn, the spending cuts can be meaningful, especially if they occur during the early retirement years when your health is best, and you want to enjoy spending, rather than worry about markets.
Who it's a good fit for:
People with long time horizons (e.g., early retirees), strong plans, and a budget with enough discretionary spending room that a spending reduction wouldn't dramatically reduce quality of life.
What are the drawbacks:
Flexibility. Your spending moves with markets, and in a bad stretch it may move down more than once and more than you would like.
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