Photo of Ray Ferrara CFP Ray Ferrara CFP May 29, 2018

Equity markets in the US are near all-time highs and interest rates are coming off historic lows meaning bonds are expensive too. For those getting ready to retire, a bear market in these two asset classes, especially at the same time, could have a significant negative impact on portfolio values which in turn could affect the planned retirement lifestyle.

Let’s suppose that you are retiring with $1 million in savings. Most financial planners will tell you that a “safe” withdrawal rate is 4%, or $40,000 per year. If after withdrawals the investments grow then you might consider taking 4% of the higher number. But what happens if the value goes below $1 million? You need to take a smaller amount which reduces your lifestyle. Who likes that idea?

However, there is a bigger issue. You need to wait until the portfolio returns to the $1 million level before returning to your expected lifestyle and that could be a long time. If your portfolio declines by 15% in a bear market and you withdraw the 4%, the value of the portfolio is now $810,000 and it takes a return of 23.4% just to get back to even without taking into account any future withdrawals.

Bear markets (a downturn of 20% or more) generally occur once every four years, but we have not had one since March 9, 2009. Therefore, if you are newly retired, or going to retire in the near future, the likelihood of a bear market in equities sometime over the next few years is high; but no one knows for sure when it might occur. The last thing you want to do is to sell part of the portfolio at the wrong time. So what can you do to potentially protect your cash flow over time?

First, let’s talk philosophically. Maybe you have enough money that a downturn will not really affect your lifestyle. Good for you. No need to read further; or maybe there is. We believe in taking no more risk than is necessary to support your lifestyle throughout retirement. If adding more risk doesn’t bring any value to your life, why are you taking that increased risk? There is no reason to jeopardize a lifetime of savings.

Here are two of the many cash flow management strategies. First, keep about 18 months of living expenses in cash and/or cash equivalents. No, you will not earn a lot of interest in today’s world, but that is not the point. The cash equivalents and the income you earn from the invested portfolio should provide enough cash flow for approximately 24 months. When the downturn occurs, you draw against the cash reserves; this gives the invested portfolio an opportunity to potentially recover without having to sell on the way down.

A second option is the bucket approach. Here you segment your investments into buckets of generally five year increments and invest the money in such a way as to replace the previous bucket when it is empty. Each of the buckets starts with $200,000 which is designed to provide $40,000 per year cash flow. The potential earnings over time as you get to the next bucket will hopefully provide for a higher pay out to adjust for inflation. The first bucket is invested in cash and short term bonds while the second bucket to be used in five years would have intermediate bonds. The third bucket would be split about 50/50 between stocks and bonds, the fourth bucket would be funded with a split of 75% equities/25% bonds. The final bucket would be invested 100% in equites. As each bucket comes due it is converted to cash and short term bonds for the next five years. Sounds simple, but it takes skill and discipline to use this approach.

If you are within five years of retirement, or already retired, it is important to have a written cash flow plan. You worked long and hard for your money and now it is time for your money to work hard for you.

Please take advantage of our complimentary introductory meeting to discuss your retirement cash flow plan by calling 727-441-9022. By the way, we will be opening our Tampa office in the Westshore area in late summer.

The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and are subject to change.

Investment Advisory Services may be offered through ProVise Management Group, LLC.