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Three retirement checks for when you have enough

One of the most illuminating portfolio makeovers that I’ve had the chance to work on over the past few years featured Ted, a retiree employing a conservative strategy.

At age 70 and divorced, Ted was savouring life in a warm climate, spending time with his significant other, enjoying his photography (and making a little bit of money on it, too) and relishing his close bond with his adult daughter. He was extremely frugal - purchasing a small SUV that he expected to keep for many years was a rare splurge. Ted told me that he was content to make do on social security and extremely modest portfolio withdrawals of less than 2%. And his portfolio wasn’t huge at about $450,000. That translated into a $9,000 annual cash flow from his portfolio.

Ted’s portfolio was so conservatively positioned, with about 70% of assets in cash and bonds, that I had some concerns about the effect of inflation on his purchasing power, especially because he noted that his healthcare expenses were beginning to flare up. Thus, my 'After' portfolio nudged up his equity weighting to 50% of assets from 30% previously. With a spending rate as low as Ted’s, I argued, he absolutely could afford to take more equity risk. Even if his equity holdings encountered a sustained bear market, there was little to no chance he’d need to sell them in a trough. And switching into a more aggressive portfolio mix would probably enlarge his eventual balance, which he could use for travel or pass on to his daughter.

But in hindsight, I wondered if my increase of stocks in the 'After' portfolio was more reflexive than it was necessary. Yes, his bond-heavy starting portfolio had low return potential, and yes, a heavier equity allocation would likely bump up returns, albeit with extra volatility. But given Ted’s modest spending, he could afford to maintain a more conservative asset mix that provided him with more peace of mind than he’d be able to have with a more stock-heavy portfolio. His portfolio was enough.

‘If you’ve won the game...’

Ted’s approach reminds me of the saying I most closely associate with asset-allocation guru Bill Bernstein:

“If you’ve won the game, quit playing.”

The basic idea is that if you’ve built your portfolio up to a point that it meets your goals, you don’t need to keep gunning for additional returns. Instead, you can switch your focus to extracting your cash flows from a more conservatively positioned portfolio that provides you with peace of mind.

Ted’s case is also an illustration that you don’t need to have several million dollars to shift into the 'enough/peace of mind' camp. People of more modest means can get there, too. The key is that the portfolio spending rate must be low enough to make it work, and the portfolio should be positioned to support that spending as well as to accommodate inflation and short-term spending shocks.

At the same time, maintaining a very conservative portfolio can introduce risks of its own. The portfolio may not grow enough to support the planned spending rate, or that spending could increase due to inflation or a lifestyle shock, such as long-term care expenses later in life.

If you’re inclined to de-risk your portfolio for retirement because your spending rate seems low relative to your portfolio size, be sure to consider the following as part of your calculus.

1. ‘Safe assets’: low return drives low withdrawals

A key consideration for investors attracted to a less volatile portfolio that features lower equity exposure is that the return potential of fixed income assets has dropped markedly over the past several decades. Current yields are a good predictor of what bonds will return over the next decade, and the 10-year bond yield is just 0.70%. Other high-quality bonds (and in Australia, perhaps term deposits) yield a bit more, but it’s hard to push yield much over 2% without taking substantially more risk.

That has implications for safe withdrawal rates. After all, the 4% guideline has only been stress-tested over periods featuring much higher yields, and the back-tests featured a balanced equity-bond portfolio, not one that skews heavily toward bonds. That suggests that retirees who wish to maintain very conservative portfolios also need to be similarly conservative about their withdrawal rates. Ted’s 2% withdrawal rate doesn’t seem too far off the mark. The trouble is many retirees won’t find that to be a liveable income stream.

2. Spending could change

And even as you might have a disciplined spending plan in mind for your retirement, it’s also worth bearing in mind that in-retirement spending isn’t 100% within your control. While inflation has been fairly benign over the past decade, running well below historical norms for most categories, it could run higher in the future. (High government spending to ward off a recession could stoke inflation, though many experts also predicted inflation following the global financial crisis from 2007-09 and it didn’t materialise.) It’s also important to consider that your own inflation experience could be different from CPI at large, especially if healthcare-related costs consume a large share of your spending. Higher inflation has the potential to drive your overall spending - and in turn your withdrawal rate - higher than you intended, even if consumption remains the same.

In addition to inflation, it’s worth considering that what you spend money on - and in turn your total spending rate - might change over your retirement life cycle, too. Research from Morningstar Investment Management’s Head of Retirement Research David Blanchett points to spending tapering down in the middle years of retirement, then flaring up toward the end, largely due to uninsured healthcare costs. If you haven’t made a plan for long-term care expenses should they arise, it’s particularly important to factor in those potential costs.

3. The value of a second opinion

There are so many moving parts in creating a retirement plan; changes in one part of the plan have repercussions in another. For that reason, it's valuable to get a professional opinion on any asset allocation or withdrawal setup you're contemplating, to understand and troubleshoot any unintended consequences.

It's also worthwhile to consider all of your spending sources together - not just your portfolio, but also any income you'll derive from pensions or any other sources. After all, if your aim is to create a conservative plan, one of the best ways to ensure that is to create a baseline of retirement cash flows through non-portfolio sources to cover very basic living expenses. That takes pressure off the portfolio and portfolio withdrawals, which in turn can contribute to peace of mind.


Christine Benz is Morningstar's Director of Personal Finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. This article does not consider the circumstances of any investor, and minor editing has been made to the original US version for an Australian audience.

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Marvin Cathey
September 26, 2020

Just a thought. I’m no financial planner but I’ve always thought bonds have the advantage over term deposits of being able to be sold before expiry date. Term deposits fixed in the reply above of $9000 each year for 2,3,4,5 years are not that flexible. Plus plans change particularly if medical issues require sudden financing. So on that score alone I would prefer the flexibility of bonds over term deposits and more so the longer the maturity dates. Bond maturing in 2025 can be sold tomorrow. Term deposits can be repaid earlier too but at the whim of the bank AND loss of interest.
What am I missing

Philip Carman
July 10, 2021

That bonds can - and do - fall in value when interest rates rise...
Term deposits remove that risk, but at the 'cost' of liquidity. All investing is about compromise and balancing risks against rewards. Consider this: if interest rates rise from their current low rates to (say) 2%pa higher, that would be a tripling of returns on a basket of < 24-month duration TDs and perhaps similar for bonds of about 48-month duration. The TDs would not fall in value, but would cost to withdraw and take up higher rates elsewhere. whereas the bond may have fallen in value by some 30 - 40%.

September 23, 2020

In this low interest environment “bond funds” could prove to be risky because when interest rates do start to rise, which will occur in the course of time bond funds will suffer a substantial “capital loss”.

An alternative approach could be using (capital + interest) to provide the first six.years cash flow requirement of the specified $9,000 per year. Assuming a cash/term deposit interest rate for this exercise as 0%, place $9,000 per year in term deposits maturing in 1, 2, 3, 4, and 5 years and $9,000 in a cash account for the first year’s cash flow. The second year’s bulk of cash flow being provided by the maturity value of the maturing term deposit.

That requires $54,000 of existing capital. The balance $396,000 capital available invested in about a 10+ (quality) share portfolio in mature “dividend paying” established companies.

Then every year thereafter establish another new $9,000 term deposit maturing in 5 years to replace the term deposit that has just matured using the excess interest if any from the term deposits, annual share dividend payments, annual refund of the dividend imputation tax credits and (if necessary) realise some capital gain from the share portfolio.

As the annual requirement of $9,000 specified is rather modest there should be no requirement to need to have to realise any capital gain.

The cash and term deposit to provide the first six year’s cash flow should provide sufficient time to smooth out any volatility in the share portfolio and it could increase in value.

Warren Bird
September 23, 2020

OzTrev, that's a typical misunderstanding of how bonds work. Yes, in the short term there are negative capital valuation movements, but over the timeframe of the average maturity of the bonds in the fund you get higher returns from increasing reinvestment earnings. You can read some of my articles that explain this. One of the most popular is this one:

And also read this one that explains why a 5 year TD is in terms of financial outcome exactly the same as a 5 year bond.

I'm not saying that the strategy you suggest has no merit, but buying into a bond fund isn't in reality going to be all that different to what you propose.

September 24, 2020

Warren, could you calculate what a 1% increase in the existing bond rate do to 50% to 70% of the available $450,000 by way of capital loss.

Personally, my opinion is that investing in bond funds when interest rates are low is extremely risky as the capital loss would be too high if interest rates were to rise.

If prevailing bond interest rates were higher and there was an expectation that interest rates were expected to reduce you would experience a capital gain.

Lastly, the investment time horizon for a 70 year old is finite. Using the cash and term deposit strategy in my opinion coupled with a quality share portfolio could weather share market volatility and give more than the desired modest outcome sought by the portrayed risk averse investor.

Warren Bird
September 24, 2020

Oz Trev, yes I could quite easily if I knew the duration of the fund.

Bond funds are not just long term bonds, but a spectrum of maturities starting really soon. So as rates go up, yes, you get a mark down in capital value, but maturing bonds get reinvested at that higher yield. And all other bonds, whatever happens to their price initially, amortise back to par - as my article makes clear.

Yes, if you invest now you will earn a low yield and low return over the 5 years or so that you should look at a bond investment. And yes, if rates went up by 1% right now and you were in, say, a 4 year duration fund you would have a negative return this year of 4%. (See, it's easy - read my articles, it's all there!) But you would then experience higher returns as the yield is higher and you reinvest.

People have been telling me for literally the last 10 years that bond funds are about to have a disastrous time because yields are going up. I don't know if that's about to happen or not. It did a couple of years ago, but that's since turned around (and yes, I've written an article about that too - see here: Frankly, it's hard to see in a world of excess supply and post_COVID structural change that we're going to see a massive increase in yields any time soon, but it could happen.

And yes, I did say the capital loss in year 1 would be 4% - if the fund is a 4 year duration fund. It would be 6% if you're in a 6 year duration fund. But as my articles argue, over that 4 or 6 year period that all washes out and you'll not experience that as a permanent capital loss. Bonds aren't like equities where a fall in share price cannot be guaranteed to come back. Every bond matures at par, so as my Life of a Bond article explains, whatever happens to the price along the way is just volatility, not return.

I believe that the strategy you suggest would work just as well if you held some funds in cash (for no volatility) and some in bond funds for the 5 year or so horizon, rather than term deposits. You don't mark the Term deposits in your strategy to market, but that's a false sense of security if at the end of 5 years the bond fund has given a higher return. that doesn't mean I'm arguing against your strategy. i'm just arguing against your thinking about bond funds being part of it. TD's and bonds are quite similar - as I wrote in my very first FirstLinks article here:

I hope I'm shedding light not heat here. That's the intention.

September 24, 2020

Warren, the strategy i propose is to provide the “required defined cash flow each and every year” using the maturity capital value of each maturing term deposit.

It is a rolling five year strategy to deliver the annual desired cash flow using both CAPITAL and earnings. I assumed a 0% interest rate to simplify the explanation of the strategy.

I selected the five year rolling period as that appears to be generally speaking the sweet spot offered on interest rates available in the marketplace.

Remember the investment horizon in retirement is finite, not perpetual such as that experienced by perpetual superannuation funds in the accumulation stage.

The portrayed risk averse investor in this hypothetical example is not subject to “mark to market up/down valuation” of a bond fund but gets the necessary specified cash flow.

I am very well aware that holding a bond to maturity you get the contracted interest rate at the intervals specified and on maturity the initial capital value.

What we have not discussed is the type and quality of the underlying government guaranteed, unsecured corporate or commercial bonds and their inherent investment risk. Or could the underlying bond be comprised of securitised factored debt.

Most bond fund managers do not divulge in detail the make up of the bond fund so that an intelligent risk assessment can be made.

Plus what is the annual investment management charge made by the bond fund manager?

Whereas, the term deposit strategy does not incur any investment management fees.

September 26, 2020

Warren, Under what circumstances does it make sense to have any government guaranteed bank TDs right now, regardless of duration? It seems impossible to get even 1% gross return. In contrast, no-fee cash at call accounts can pay twice TD rates, provided you are careful to manage promotional rate expiry. e.g. We recently ended a Macquarie 2.65% 4-month $250k promo onto their current 1.35% on up to $1m. We could switch $250k to Rabobank's 2% for 4 months. There are similar deals around.

Jeff Oughton
September 23, 2020

Agree - finances are only one element of your (retirement) lifestyle portfolio. Stress test your financial plan - every year - and review accordingly, especially if unanticipated risks emerge and sustained.

Your health (mind and body), family, friends, social activities and continued growth in your human capital and overall well being also need to be integrated with your net wealth and cashflow....and in Australia, fortunately, there's a lot of public support for older Australians.

What's enough assets/income for your life journey needs to be optimised taking into account all these activities. And it's full of opportunities & risks! It's your lifestyle....and you need a living plan; or just drift and enjoy the ups and downs waiting to be bailed out or not!

September 23, 2020

Ted is being mugged by the Age Pension (AP) asset taper rate.

According to

Home owner Ted's deemed assets == AP:
1. $0 == $24,552 / y.
2. $252,826 == $24,552 / y.
3. $582,834 == $0 / y.

Ted would be much better off tossing the income reducing part of his assets, ($450,000 - $252,826) = $197,174 into his home, the value of which could be realised later when needed.

It may be that 'his significant other' is also an Age Pensioner and that $450,000 is their combined deemed assets - in which case they do not have an income reducing part of their assets and have a combined income of 2 * $18,507 / y = $37,014 / y.

With no special effort or deprivation, our fully accounted LIVING expenses last year were $19,500 + ~$4,000 depreciation = $23,500. Had we been eligible for the Age Pension, we would have saved $37,014 - $23,500 = $13,514. We could have used that money to build non-deemed Stairways to Heaven.

September 23, 2020

The conundrum described permeates all facets of life, finance included. 'Conservative' bonds expose us to credit, sovereign and interest rate risk. Equities involve demand / supply, agency and trading risks. Touchy-feely assets are often concentrated, and special purpose. Operational and fraud risks are common to all. Those lucky enough to have 'enough' (itself a volatile concept) are best advised to learn of these and their range of impact. Adding personal preferences (wants vs needs) and behavioural quirks (how would a 50% fall in the nest egg affect you: disappointment, despondency or driven to suicide?) accept the changes, including upsides. Managing expectations and if necessary, curtailing consumption might make the journey tolerable. For some even enjoyable. This trumps the alternatives of chasing one's own tail and generating misery for self and family.


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