I’m trying to find out the name and more information about this method of converting your portfolio into retirement income. My Google-fu is weak, apparently, because I can’t find anything directly relating to it.
Here is the plan: You keep 80% of your investments in stocks and 20% in cash (or equivalents). Each year, you sell 4% of your portfolio and add it to the cash. You then divide the total cash by 5, and that is the amount of money you have available to live on for this year.
Does anyone know the name of this method? And is there anywhere where this method is discussed in more detail?
I don’t know what it’s called, but I don’t think I’d advise using it. If you you retire at age 65 and earned 0% on both your stock and cash accounts, you’d still have 30% of your original amount left at age 95 and 20% of your money left at age 100. You would have spent less than 4% of your initial balance each year of your life.
If your stock account grew at a very modest 5% and you earned 1% on your cash, your account would be growing. at age 100 you’d have over $1 million in your stock account and more than 200,000 in your cash account.
It depends on what you want to do. If this method gives you enough money to live comfortably, if you want to allow for disaster (such as a long-term collapse in the stock market), and if you want to leave money to your children, your grandchildren, or your favourite charity, then this method makes a lot of sense.
Models for retirement income depend on assumptions about growth. These assumptions are based on past performance, but no one can predict the stock market. The safest portfolio is enough cash to last through retirement, but if you don’t take advantage of real growth then you are losing value. Take the most conservative approach possible given the amount of cash needed to last through retirement.
Taking 4% of a portfolio each year is supposed to be a sustainable way to live off of investments. It’s a tried and tested method to make sure your money lasts until you die (at which point it’s passed onto your heirs who should do the same, on retirement).
Of course, this is based on a large assumption that your portfolio grows over the long term.
I suppose this new method, 80:20, is based on assumptions that stock market growth is going to be lower and interest rates, in comparison, higher than previously. It’s an interesting ‘solution’ to a world where stock markets grow more slowly (or where perceived risk is higher). I expect, if your overall portfolio is of sufficient size, that the ‘cash’ portion would be in TIPS or CDs.
The rationale is the 20% cash allotment gives you 5 years to absorb short term stock market loses. It’s not perfect, because you might have to sell when stocks are temporarily down. However, if you’re invested in something that replicates the S&P 500, you’re going to get - I’ve lost track, 2%? 3%?, in dividends a year, so that could account for some of the 4% you’re talking out of the portfolio.
It’s called a bucket strategy, but usually has at least three buckets. The short term bucket is held in extremely conservative investments, cash, money market funds, T-bills and such. The medium term bucket is held in longer range investments, a little riskier than the short term but still pretty safe, corporate bonds, preferred stocks, blue chip dividend stocks. The long term bucket is what is held in growth stocks with a view towards growing that investment but willing to tolerate a 10 or 20 percent loss in a down market. Sophisticated versions might have 4, 5, or 6 buckets with REIT’s or foreign stocks in their own buckets.
Thanks for the reply. That isn’t exactly the method I’m looking for, however. I can see how the bucket strategy is similar.
The method for which I’m looking for the name (or more information) is different than the one in this article. Note that this article is written by Morningstar and recommends lots of funds with relatively high expense ratios.
The method I’m asking about has 80% of the portfolio in a low-cost index fund, such as Vanguard’s S&P 500 index fund and 20% in cash or no-risk cash equivalents. The cash portion represents 5 years of living expenses.
Every year, you sell 4% of the portfolio, add it to the cash stash, then use 20% of the 5 years cash supply as your income for that year.
If 20% of your assets is 5 years living expenses, then you’ve got 25 years living expenses to work with. Starting from that point, it’s would be difficult to come up with a retirement strategy that won’t work out in most cases. I suppose if you lived to be 110 inflation might rob some of the value, but in that case I’d expect the income from the portfolio to track inflation.
Sounds like a variation on what has been called the “Galeno strategy” - originally described here but posted in other variants on many other boards. See this Boglehead wiki entry.
Yes, the Galeno Strategy was what I was looking for.
As the Bogle Wiki described, many of the withdrawal strategies experience large variations in the amount you withdraw each year. The Galeno strategy “smooths” that out considerably by averaging over 5 years the amount you have in any one year.
I think the implied point of a lot of these is that your “living expenses” (or at least the amount you can afford of them) is determined by the formula, not the other way around. In other words, this same plan “works” if they person has $12.18 in savings, but their living expenses for that year would be about 40 cents. These are techniques for determining what you can afford to live on (for a given long-term outcome, like not decreasing principal or having it hit zero on your death date), given whatever amount of savings you’ve got.