A strategy based on research from experts in the field of financial planning provides a sensible approach. It involves opening three accounts: a local checking account, a cash flow reserve account and an investment portfolio.
In the previous five articles of my series on “Building and Managing a Retirement Portfolio,” we addressed several investment management issues, challenges and recommendations for those who are ready to or have already retired.
Now, let’s look at an investment and spending plan. This would plan offer benefits that are critical to reducing our chances of running out of money:
Portfolio diversification, which serves to lower portfolio risk, provides both current income and future portfolio growth and increases tax-efficiency.
Sufficient liquidity to meet both anticipated and unexpected cash needs.
Flexibility to avoid the damaging effects of selling assets during bear markets.
Increased portfolio longevity.
A strategy based on research from experts in the field of financial planning provides a sensible approach for addressing each of these goals. It involves opening and managing three accounts: a local checking account, a cash flow reserve account and an investment portfolio.
Checking account:This is the “spending” account, which receives the income flows from sources such as Social Security, employer pension, part-time work and any required minimum distributions. Any additional funds needed to bridge the monthly income gap (difference between pretax income and pre-tax expenses) flow into this account at the beginning of each month from the cash flow reserve account to help meet spending needs.
For those fortunate enough to have more income than expenses, the excess flows can be reinvested in the investment portfolio. However, for this example, let's assume the retiree experiences an income shortfall.
Cash flow reserve account:We fund this second account with approximately two year’s worth of living expenses (plus any funds required for planned short-term goals such as a wedding, home renovations, etc.). One year’s worth could be invested in a money market fund and one year’s worth in a low-cost, high-quality short-term (i.e. one year) bond fund.
This money will be readily available in liquid funds largely unaffected by the state of financial markets, providing certainty and peace of mind that the retiree will have enough money to pay the bills for two years. Think of this as the retirees’ payroll account from which they draw their monthly check for deposit into the checking account.
This account can be refilled periodically from the third account: the investment portfolio (IP). Deposit money from the portfolio’s cash flow, or during the portfolio rebalancing process.
Investment portfolio: The bulk of a retiree’s financial assets will be in the investment portfolio, which is composed of a diversified mix of bond and stock funds. It is designed to lower risk, improve tax-efficiency and produce both income and long-term, inflation-adjusted growth.
This account will contain assets you are confident can remain invested for five years or longer. To provide additional protection that spending needs will be met even in the event of a severe and prolonged downturn in the financial markets, the bond portion of the portfolio will include short-term and intermediate-term bond funds that can be liquidated to generate cash.
These investments are less likely to sustain significant losses during bear markets, and, depending upon an individual’s personal preference, they can meet an additional three to five years of spending needs.
Although there are no guarantees this five-to-eight-year window will insure you never need to sell assets at a significant loss during a bear market, it greatly reduces the chances that you will.
This article is for general information purposes only and is not intended to provide specific advice on individual financial, tax, or legal matters. Please consult the appropriate professional concerning your specific situation before making any decisions.
John Spoto is the founder of Sentry Financial Planning in Burlington, Mass., and Danvers, Mass. For more information, call 781-685-4928.