From Retirement Now Newsletter July 22nd 2021

Perhaps the best book on passive, low-cost, index fund investing is Burt Malkiel’s A Random Walk Down Wall Street.

He makes the case that buy-and-hold is generally the way to invest over the long-term.

But he also includes some handy info hidden toward the end to reward those that choose to finish the book. And one of those nuggets of wisdom is contained in a paragraph under a sub-heading inside a chapter on lifecycle investing. And if you find this nugget you will be rewarded greatly.

And here is the gist of it:

When determining which investments in your portfolio to sell to generate retirement income, sell the ones that would naturally bring your portfolio back to its target allocation.

He uses an example of a person that has a 50% stock and 50% bond portfolio.

Over time the stocks are likely to outperform the bonds. Which will cause the portfolio’s allocation to shift to a higher percentage of stocks, say 60%, with the 40% remainder still in bonds.

This causes the portfolio to be riskier than the original target allocation. And re-balancing (i.e. selling some stocks and buying some bonds in this example) is important to maintain the desired allocation.

When determining which holdings to sell, look first to the ones that are over-allocated.

You get income from the sale, and you re-balance at the same time.

Going beyond the book now… he doesn’t mention what to do when you need income AND your portfolio allocation is already correct.

One approach to that situation is to sell shares in equal pro-rata dollar values to generate income and maintain the target allocation at the same time.

And the next big question is, “But what if my portfolio is temporarily depressed due to a bear market or market correction? If I sell equities I’ll take a loss, should I wait until the portfolio bounces back?”

In this situation you have some options.

You may be able to reduce withdrawals temporarily (tighten the belt) during the economic downturn.

Or you may could continue withdrawing pro-rata amounts from your portfolio to maintain it’s target allocation, remembering that when the study that gave us the “4% safe withdrawal” rule was done, it assumed withdrawals continued consistently throughout each 30-year period, even during market downturns.

Or you may could temporarily stop withdrawals from your portfolio so it has some time to rebound. In the interim if you are keeping 6-12 months of expenses in cash on hand, you could tap into that.

Or you could do what one friend of mine called “portfolio triage” where you sell the investments in your portfolio that are least impacted by the recent market correction. This would likely be things like bonds. If you had a portfolio with 40% bonds, using a 4% annual withdrawal rate could help it last approximately 10 years, using quick and dirty math. Historically, markets have rebounded by then.

But notice (and this is the genius of using withdrawals as a form of re-balancing), that if your portfolio is temporarily down due to a market correction, it is very likely that it was driven down by the performance of your equities (i.e. stocks). Suddenly the 50/50 portfolio may now look like 40% equities and 60% bonds in a bear market.

Thus, by re-balancing you would by default be selling bonds to generate your retirement income.

Sure, bonds and bond funds can decline in value due to changes in the market (especially interest rate changes), but they aren’t likely to decline as much as equities. Thus you could be accessing investments that have not lost as much value.

Anyway, it’s food for thought.

And the best action for any individual to take will be different based on their own situation.

Conclusion: There are no hard and fast rules that apply to one hundred percent of people. But if you need help figuring out how to generate income from your savings in retirement to help you not run out of money, then feel free to click here for a 15-20 minute chat with me. If I can’t help you I’ll be the first to say it, but I will try to point you in the direction if you’re ok with that.