When you retire and begin to support yourself with portfolio withdrawals, life changes for your portfolio as well as for you. There are new risks, taxes, and other considerations for your investments; new questions about how best to raise the cash. Often there are unexpected emotions that arise as you draw down assets, causing cracks to appear between funding your retirement dreams and wanting to make the money last. A retirement cash-management plan can help bridge the gap.
Lifecycle of a Personal Portfolio
There are, broadly speaking, two stages in the life of a personal investment portfolio - the accumulation stage and the decumulation, or distribution, stage. The first gets most of the attention in personal-finance advice, but the second stage can be trickier to navigate.
Here’s a brief video highlighting the differences:
Financial economists tend to focus on the investment risks for retirement portfolios, and for good reason. If a portfolio no longer receives investment contributions, there’s no ability to replenish the accounts after a market decline or to take advantage of lower asset prices with new cash. Market declines may also mean you’re forced to sell assets that were worth a lot more just a short while ago to raise money for spending.
A few years of poor investment returns combined with steady withdrawals can severely erode a retirement nest egg. This is the dreaded “sequence of return risk” about which economists warn, and it can wreak havoc on a financial plan.
Meanwhile, there are new considerations for the portfolio withdrawals. Some types of accounts are taxed differently than others. Certain retirement accounts are subject to required minimum distributions each year. Ideally, you are considering these details as you raise cash for spending in order to minimize the tax burden while maintaining your desired stock-bond allocation, which itself can be trickier now that you’re regularly pulling money out of the portfolio.
One of the biggest challenges, though – and least anticipated – are the strong emotions that withdrawing cash can elicit. Especially for people who diligently saved and invested over several decades to afford retirement, doing so runs counter to long-established habits. As one client told us, “After a lifetime of growing the money, it feels kind of wrong to turn around and start spending it.” Another client shared that positioning the portfolio to support withdrawals made them feel older, since it was now an “old-lady portfolio,” no longer aiming solely for growth.
It can also be harder to ignore the continual stream of investment noise about why the markets may fall tomorrow when you’re no longer working. Without the reassurance of a monthly paycheck, with more time to hover over headlines, and knowing that you’re counting on what you have to keep you safe, your nest egg may feel vulnerable to an enormously hostile world.
The risk is that you decide to curb or even abandon long-held dreams for which you worked hard to save the money. While reducing expenses during economic downturns can help, being “conservative” comes with its own risks, since deferring a dream might mean losing it forever if a health event or other surprise intervenes.
The question becomes, how can you manage to withdraw a steady stream of cash for spending to replace the steady paycheck you had before, through the ups and downs of the markets as well as your personal circumstances that you will almost inevitably experience along your retirement journey?
Answering this requires more than a spreadsheet. It requires figuring out where on a continuum between portfolio optimization and safety you sit, based on personal preferences and spending needs, in order for you to feel comfortable using your financial resources as intended.
Actually, you’ve already signed on to this concept if you’ve been employing a diversified portfolio. The minute you added bonds to protect against risky stocks, you accepted that there was a balance to strike between “perform well” and "sleep well.”
In retirement, there’s simply one more step to take: establishing a cash-management plan for your investments to fund your spending needs.
Personal Pension Plan - A Balanced Approach to Cash Management
Here’s the cash-management strategy – what we call your “Personal Pension Plan” – that we’ve found effective in navigating the varied economic circumstances of the past two decades:
As the video describes, we recommend that you:
Hold one to two years of expected portfolio withdrawals in a separate account for cash reserves.
Set a minimum and maximum dollar amount for these cash reserves – typically one to two years of expected cash withdrawals – so that you can monitor and replenish them.
Distribute money quarterly from cash reserves to your bank account for spending.
You can establish the cash-reserve account anywhere you like - e.g., as a separate brokerage account, or a high-yield savings account. The important thing is that it be separate from both your investments and your bank account. Thus positioned, the cash reserves, or “reservoir,” helps regulate the rate of flow from the portfolio to your bank account. It also serves as your emergency fund for surprises.
Sometimes people object that “cash is not being put to work,” or is a drag on investment returns. Yes, cash has much lower expected returns than stocks, but so do bonds, and you can choose to view cash as simply an extension of your fixed-income holdings. More important, providing “liquidity” is the primary work of cash, which is there for immediate use – a promise that stocks and bonds can’t make.
Most retirement plans span several decades. In this context, securing cash for a year or two of expenses plus the occasional financial surprise is not a large amount in the grand scheme of things, particularly if it helps resist the temptation to bail on your investment strategy during market downturns, or better yet, prevent temptation from rising at all, as has been our experience through several dramatic market declines over more than two decades.
Another question that comes up is why not simply draw on cash directly from the investment accounts? After all, cash continually arrives in the accounts throughout the year from bond interest payments, stock dividends, and mutual-fund distributions.
Yes, but the cash provided by a diversified portfolio is usually not enough to support portfolio withdrawals, which means you’ll still need to sell some positions periodically to meet your spending needs.
Also, the cash in the portfolio can’t offer the separate benefit of serving as a buffer, literal and figurative, between you and the markets, since it’s lumped in with the investment assets, which fluctuate day to day. Having a separate cash-reserve account means that you don’t have to interact with the volatile portfolio when making withdrawals; you’re interacting with cash that has already been set aside for spending.
Waiting to withdraw money from your portfolio until the moment you need it treats your long-term investments like an ATM machine. What if you walk up to the ATM right after the markets have dropped?
Finally, some people ask, why bother with any of this, why not just cash out the portfolio and buy rental real estate or a low-cost immediate annuity providing guaranteed income for life? These can be a big help, but every strategy comes with its own risks, so usually aren’t a complete solution for most people.
For example, immediate annuities typically lack cost-of-living adjustments like those that apply to Social Security, which can be a problem over time. Also, you can’t access additional amounts when you need to cover a surprise event with a large sum of money. Rental real estate usually involves work, and there may be times when the properties are vacant and not providing income.
Given all this, having a diversified portfolio for retirement funding offers important advantages, but taking advantage of them requires a new approach for harvesting cash. Establishing a Personal Pension Plan addresses the investment concerns as well as the emotional ones, striking a balance between a “perform-well” and “sleep-well” system of financial management. It can help you feel more in control of your finances and increase the odds that you’ll enjoy the money you worked hard to accumulate.