Retirement Withdrawal Plan
You have spent your entire working life preparing for retirement. It’s finally here and now you are wondering: How do I now handle my finances once I am finally in retirement? At J.A. Lawrence Wealth Management we believe the answer is simple. You must use a well-diversified two bucket retirement strategy. Later on, in this article we will articulate how the two-bucket strategy would have held up in one of the worst retirement eras in modern times, 2000-2007.
First, let’s talk about what the two-bucket retirement strategy is. Imagine that you have two separate buckets. Each bucket contains a varying amount of the assets you have accumulated during your working life. The first bucket will be your defensive cash bucket. The second bucket will be your growth bucket containing stocks. Throughout your retirement you will make withdrawals from one of these buckets. In a bear market, retirees will make withdrawals from their cash bucket in order to protect against having to lock in losses in a down market. During a bull market, retirees will make withdrawals from their stock portfolios. These withdrawals will fund living expenses and replenishing the cash bucket when needed.
BUCKET 1: This is your cash bucket. This bucket serves as the foundation to your retirement. In a perfect world a retiree would want to have 3-5 years of living expenses in their cash bucket. The range here will be dictated by your own personal finance situation. It would not make sense to hold five years of cash if this sum depleted your second bucket to the extent you could not live on the growth. Ultimately this cash bucket will be dictated by the amount of expenses you will have when entering retirement. Many retirees may view such a large cash bucket as wasting investment opportunity. Some retirees may be apprehensive to having so much cash eroding away to inflation. Please understand this cash is acting as insurance. Just as you pay for insurance to protect your home, cars, and health. We must pay for this cash insurance in our portfolio. We simply pay inflation costs for this cash to protect or second growth bucket. Its just that simple.
BUCKET 2: This is the investment bucket. This bucket will hold the bulk of the assets you have accumulated during your working years. As this bucket grows with the market, retirees will withdraw living expenses from this bucket. A highly encouraged withdrawal rate is between 4-6% by many investment advisors. Excess growth can be reinvested in this bucket or allocated into the cash bucket if circumstances dictate. between 2009-2019 this was an incredibly easy strategy in a long bull market. There is a high chance a retiree would not have had to even touch the cash bucket.
The key to this bucket is simple: diversification. Bond interest rates are so low in this environment that the risk return rate just does not make sense today to own bonds. Therefor retirees are forced into stocks. Retirees must be as diversified as possible within this one asset class being stocks. At J.A. Lawrence Wealth Management we suggest owning the entire world for this second bucket. How can a retiree own the world? Its simple. Buy a low-cost weighted index fund with this philosophy in mind. There are several index funds out there that provide this diversification. The Vanguard Total World Stock Index Fund for example is a fund that owns approximately 7800 different stocks around the world! This provides investors protection against any one company, any one currency, or any one sector of the world. This is the level of diversification retirees need for their second bucket.
We know the two-bucket strategy would have done great during the last 10-year bull market. So, let’s look at how the two-bucket strategy would have held up between 2000-2007? The year 2000 was one of the worst years a retiree could have begin retirement in modern history. We will use a Roth IRA (tax free withdrawal) account value of $1,000,000 and a cash bucket of $300,000. We will assume a 5% withdrawal rate. We will use the VHGEX (Vanguard global equity fund) as our global investment vehicle. For simplicity we will not even include dividends.
EXAMPLE: From Jan. 2000-Jan. 2001: the VHGEX lost 13%. A retiree would have pulled $50,000 in cash from their first bucket.
January 2001 Account balances- Roth IRA: $870,000 Cash: $250,000
January 2001-January 2002: The VHGEX lost another 5% year over year. Our investment account would have been down a total of 17%. A retiree would have pulled another $50,000 from the cash bucket.
January 2002 Account Balances: Roth IRA $830,000 Cash: $200,000
January 2002-January 2003- The VHGEX lost another 12% year over year. Our investment account is down 21% in total from original investment. Retiree would have pulled $50,000 from cash balance.
January 2003 Account Balances: Roth IRA $790,000 Cash Balance: $150,000
January 2003-January 2004: The VHGEX increased year over year approximately 40%. This brings the retiree account value up about 7% from original investment. The retiree would pull $50,000 from investment account and place $20,000 into the cash account.
January 2004 Account balances: ROTH IRA $1,000,000 Cash Account: $170,000
January 2004-January 2005: The VHGEX was 15%. The retiree would have withdrawn 5% for living, placed 5% into the cash bucket, and reinvested 5%.
January Roth IRA Balance: $1,050,000 Cash Account: $230,000
January 2005-January 2006: The VHGEX was up another 15%. The retiree would have withdrawn 5% from the Roth IRA, placed 5% into the cash bucket, and left another 5% in the IRA for to be invested.
January 2006 Roth IRA account balance: $1,102,500 Cash Account: $282,500
January 2006-January 2007: The VHGEX was up another 15%. The retiree would have withdrawn 5% from IRA, placed $18,000 in cash account, and reinvested the remaining into the Roth IRA.
January 2007 Roth IRA balance: $1,194,750 Cash Balance: $300,000
As you can see a retiree entering retirement in one of the most difficult times in modern history would have weathered the storm with the simple two bucket strategy. Keep in mind this example didn’t include any dividends or even social security. Having enough cash provides the defense to weather downturns. The “own the world” investment strategy provides the diversification to trust your growth strategy.