Optimizing Spending and Investing During Retirement - Theorem Wealth Management

Client Login

Complete the required fields below in order to access this digital guide.

October 6, 2020  |  Finances

Optimizing Spending and Investing During Retirement

Follow us

Investing during retirement follows the same “first principle” that investing during your working years does – you want to stay consistently invested, so that your risk-taking can be rewarded over the long term.

The biggest change is that in retirement, your spending – big, small, planned and unplanned – has to come out of your savings and investments. Most people may have a more conservative asset allocation in retirement because you won’t have the same ability to recover losses as you may have had with your pre-retirement asset allocation. You also won’t have the luxury of an extended period of time to recover.

Additionally, you want to avoid having to liquidate investments that have dropped in value. A down market can put pressure on your income stream. Generating cash by selling investments that have not recovered their value crystalizes the loss. It’s also important to be sure you have accurately estimated your expenses, so you don’t have to liquidate stocks to cover unexpected expenses.

Here, we take a look at some of the spending and investing rules of thumb you should follow so your retirement funding is aligned with both markets and your lifestyle.

Create a Spending Plan

Once your employment days are over, it can be a difficult adjustment to no longer have a steady source of income. Taking a careful look at your outflows, from monthly expenses, to splurges, to likely big-ticket items such as home maintenance or replacing an automobile, is critical to setting up a budget that gives you the freedom to enjoy your retirement, without being afraid of running out of money. 

Traditionally, a good benchmark is to take between 3-5% of the total value of your investments in distributions annually. This is known as the “4% Rule.” The assumptions behind this are:  1) You set a target allocation when you begin retirement of approximately 60% stocks and 40% bonds and rebalance to that allocation every year. 2) Future long-term market returns will look like past returns. 3) Your income needs will be stable throughout retirement.

The 4% rule came out of a study of market returns over 30-year periods from the 1920s to the 1980s. The goal of the study was to uncover a very conservative percentage withdrawal that would preserve retirement assets over the length of a 30-year retirement, regardless of what happened in the market.

Theoretically, it works. However, further research has shown that there are two main challenges against this rule. The first is economic: very high inflation (think double digits) for an extended period, which would significantly increase the cost of living for the retiree. The second is market related. Surprisingly, a huge market drop like 2008 isn’t a problem as long as it’s followed by a quick recovery. But an extended period – 10 years – of mediocre returns would put significant pressure on retirement plan asset levels. [1]

There is some evidence that expenses remain stable or even decrease in retirement. The U.S. Bureau of Labor Statistics cites a 2017 study in which average annual expenditures were stable between ages 65 and 74 and then dropped after age 75. The problem is that some expenses are out of your control, such as unanticipated family needs, like adult children moving home or needing assistance. And of course, a significant healthcare challenge can upend this plan.

If you can’t completely cover your expenses on that amount of annual withdrawals, you may need to scale back or make other changes. Fortunately, if this doesn’t sound like a strategy for you, a more modern approach has developed in the “U-Shaped Curve” strategy. The theory behind this is based on observations of retiree behavior that point to a different income path in retirement. It turns out that younger retirees tend to underestimate the amount of income they need – mostly because they are not taking into account the cost of their active lifestyles.

Early retirement can create an effect in which spending ticks up as relatively young, active retirees travel and achieve other lifelong goals– and then comes the reality of the finiteness of the plan value, or just simply slowing down as aging progresses. Spending tends to decrease and then level off as retirees get into the middle years of retirement.

Spending increases again towards the end of retirement, usually due to healthcare costs. The average cost of healthcare and medical expenses in retirement for a 65-year old couple retiring in 2019 is projected to be $285,000 according to Fidelity’s annual Retiree Health Care Cost Estimate. And that’s before factoring in the cost of long-term skilled nursing care, which can cost as much as $10,000 per month. [2]

The investing response, if the U-shaped curve is the model, would be to invest portfolio allocations at a higher percentage of stocks early in retirement, shift to 60/40 in the middle years, and depending on market conditions, increase stock allocations again in the later years.

Increase Your Cash Balance

If you do have an unexpected, larger expense it’s important to make sure you don’t have to liquidate investments.  Shifting your portfolio allocation so you are holding as much as five years’ annual expenses in cash or safe, liquid investments can provide a helpful buffer.

Rebalance Your Portfolio Regularly

You will most likely maintain some of your asset allocation in equities, to continue to provide the possibility of growth during your retirement. In years when the equity market has a strong showing, it can throw off your asset allocation because the value of the equity holdings increases above what you originally allotted. To keep things in balance and avoid unintended risk, you should work with your investment professional to rebalance your portfolio at least annually.

Don’t Get Emotional

The biggest change between your pre- and post-retirement investing self is that you have less time to make up for years in which market returns struggle. However, it is still critical that you remain consistently invested and not try to time the markets. You should determine your risk profile with your investment professional, taking into account not only your income needs and the length of time you’ll need the money to last, but also your own level of comfort with the risk of your investments.

If you develop an asset allocation that reflects all three needs, you should be able to ride out difficult market environments without looking at your dropping portfolio balance and wanting to cut losses. Instead, if you stick to your annual rebalance, you may end up buying more of positions that are at lows, which means you can recover quicker if the market turns around.

It’s All About Balance

With a little planning and strategy, and an ongoing dialogue with your investment professional, spending and investing in retirement can be a happy balance that keeps you engaging in all the things you love to do, and continuing to meet your own personal goals.

Be sure to check out our Retirement Guide

[1] “How Has The 4% Rule Held Up Since the Tech Bubble And The 2008 Financial Crisis?” July 29, 2015, Nerd’s Eye View, Stephen Kitce

[2] Fidelity Benefits Consulting estimate; 2019

Registered Representative of Sanctuary Securities Inc. and Investment Advisor Representative of Sanctuary Advisors, LLC.– Securities offered through Sanctuary Securities, Inc., Member FINRA, SIPC. –  Advisory services offered through Sanctuary Advisors, LLC., an SEC Registered Investment Advisor. – Theorem Wealth Management is a DBA of Sanctuary Securities, Inc. and Sanctuary Advisors, LLC. This communication has not been reviewed for completeness or accuracy, does not necessarily reflect the views of Sanctuary Securities, Inc. or Sanctuary Advisors, LLC., and is not a recommendation or endorsement of any product, service, or issuer. Third party posts do not reflect the views of Theorem Wealth Management or Sanctuary Securities, Inc. or Sanctuary Advisors, LLC., and have not been reviewed for completeness and accuracy. All further communications from this representative must be sent from and received by [email protected] . For additional information, please refer to one of the following consumer websites: www.FINRA.orgwww.SIPC.org.


Share this article

Stay up to date.

Subscribe to our blog and get up to date on what’s happening today, get useful financial tips and stay informed on Theorem’s latest news.

SUBSCRIBE
Top