How is your plan working?
I am currently transitioning into “full” retirement. Seems like bad timing. The last eight months have been brutal for investors - no way to candy coat it. My stock portfolio was off around 30% earlier this year but is now only off 25% (whoo-hoo). So I decided to go back and take a closer look at my financial plan to see how my expectations of how my plan should be working, match up to the reality of this latest market “correction”.
For some background, here is a summary of how I developed my plan:
About 10 years ago, I decided it was time to get serious about building a financial plan for my wife and I to meet our retirement goals. Up until then, our financial efforts had been primarily focused on providing for our family (as they should have been) as I worked at my engineering consulting firm and my wife was a teacher. At around this time, our kids graduated from college and were on their own, so we started looking forward to when we no longer needed to generate any income from our jobs.
But I hadn’t ignored retirement up to then. I contributed to a SEP/IRA through my business, and those funds were almost 100% invested in high-growth stocks - in other words, they were volatile. While retirement still seemed a long ways off back then, I decided that I needed to write out a formal plan. Here’s a list of items I considered in my plan at the time:
- Assumed retirement age
- Social Security income
- Pension income
- Other sources of income (e.g. real estate rentals, inheritances, etc.)
- Necessary supplemental income to meet LMP (Liability Matching Portfolio)
- Emergency and contingency funds
- Remaining investment funds allocated to RP (Risk Portfolio)
- Current income and business (i.e., 10 years ago)
- “Other” considerations
I got the concept of designating an LMP and RP from the writings of William J. Bernstein, including his 2012 booklet entitled The Ages of the Investor and 2014 book Rational Expectations. My LMP is comprised of investments and cash flows that will provide a minimum monthly income (after taxes and inflation) to maintain our current life style. The idea is to have an income stream that is essentially bullet-proof (as much as possible) so that the fickleness of Mr. Market won’t change our financial lives dramatically for the worse during retirement. My LMP income sources include items 2 - 4 in the list above, and are comprised of Social Security, my wife’s pension, and rental income. However, this didn’t get me to the full amount I needed, so I decided to build a 10-year ladder of TIPS bonds (item 5) to reach my total LMP requirement. In years where I could purchase TIPS with a minimum of at least a positive real yield to maturity, I bought bonds. My goal was to provide the necessary extra funds for the first 10 years of my retirement. Since real yields for TIPS have been negative over the last few years, I fell behind. But that has changed with the recent increase in interest rates, and I have now caught up. Unfortunately, 10 years is as long a ladder as possible using TIPS, but I think 10 years is a reasonable buffer.
Item 6, emergency and contingency funds - are just that, and I am quite conservative when it comes to this— I use 18 months income as my basis - many advisors recommend only 6 months. I’ve tried to find the best place to hold this money to minimize damage from inflation while preserving liquidity and safety (if possible). Since safety and quick access are paramount, I’ve been willing to accept a low return in an interest bearing savings account up until now, though increasing inflation has me revisiting this account lately.
The RP is made up of the remaining assets after LMP obligations are met. These funds will be used for luxuries and bequests, so I can invest in “riskier” equities. For me, this means stocks, using TMF services and my own research as guides for buying and selling.
The last two items are a check list of things I wanted to keep in mind as I moved toward retirement. First (Item 8), I wanted to make sure my business was healthy and continued to provide for my needs until I was ready to retire. As it turned out, my business partner and I were able to sell our business and transition into retirement over a three year period (8 months left), thus providing extra RP funding. Item 9 was a catch-all for all the other important issues I needed to address, including things like health insurance, disability insurance as necessary, consequences of death (in other words, estate planning), and long-term care insurance.
So that is the plan I came up with 10 years ago, and I am just now starting to fully implement it. How is my plan working out? So far so good, even with the recent drop in the markets. I revisit my plan at least once a quarter and make adjustments as I deem necessary. As I note above, I’ve just finished filling the holes in my 10 year bond ladder, so for the next 10 years at least, my LMP is fully funded, and even if the markets completely crash, my life style shouldn’t change too much. I still need to consider how to best invest my RP funds, and maintain my bond ladder as the markets allow, but for the most part I am satisfied with how it is working out.
So that is how my plan is working. I present it here as an example for discussion - just one approach to a retirement plan. How is your plan working?
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