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My Four Goals

Jonathan Clements

I’M PROBABLY A YEAR or two away from regularly tapping my portfolio for income. That prospect—coupled with this year’s market turmoil—has led me to tinker with my investment mix and ponder how I’ll generate cash once I’m retired. One surprising result: I have more in stocks today than I’ve had at any time in the past three years, and I’m thinking of increasing my allocation even further.

Since 2014, I’ve thought of myself as semi-retired. I’m working harder than ever, but these days I only take on projects I enjoy. I earn just a third of what I made when I worked on Wall Street and I expect that to dwindle further in the years ahead.

That’ll leave me heavily dependent on my financial accounts. Currently, I’m 76% in stocks and 24% in bonds and cash investments. If I figure in the private mortgage I wrote for my daughter—which I consider comparable to a bond investment—the mix is more like 67% stocks and 33% conservative investments.

How am I going to take this mix of assets and generate income? I think in terms of four goals.

1. I want income I can’t outlive. The mortgage I wrote for my daughter pays me income every month. Assuming she doesn’t move or refinance, I have another 25 years of checks coming my way. At age 57, this is an income stream I hope to outlive—but I could be wrong.

I also want some income I’m guaranteed not to outlive. Research suggests our ability to manage money deteriorates as we age. Research also suggests that retirees with predictable income tend to be happier.

Where to get that predictable lifetime income? At the top of my list is Social Security, which I plan to claim at age 70. In addition, I intend to make a series of immediate fixed annuity purchases, possibly starting as early as age 60. By making multiple purchases over 10 years or so, I can buy from multiple insurers—thus limiting my exposure should any one insurer go belly up—and I’ll benefit if interest rates head higher from today’s anemic level.

I know many folks hate the idea that they’ll make a big annuity purchase, only to keel over a few months later. That’s why I like the idea of buying gradually. It lowers the stakes associated with each purchase and, by starting to buy at age 60, I’m confident I’ll get at least some income back, even if I do go to an early grave.

2. I want a pool of cash I can count on. As I buy more immediate annuities and once I claim Social Security, I’ll need less cash each year from my portfolio. But for the money I do need to withdraw, I want to be confident it’ll be there.

To that end, I’ve taken my already conservative bond portfolio and made it more so. In June, I swapped my intermediate-term inflation-indexed bond fund for a short-term inflation-indexed bond fund, and I sold my short-term corporate fund and replaced it with a short-term government fund. In other words, all my bond money is now in government bonds, and the duration is so short that it’s almost like holding cash investments.

All this reflects my evolving view of bonds. They’re no longer a good source of income. How could they be with yields so low? Instead, their sole role is to provide portfolio protection, acting as both a shock absorber and a place from which to draw spending money when stocks are struggling. My goal is to have at least enough in my two short-term government bond funds to cover my next five years of portfolio withdrawals.

Right now, I’m above that level. With 24% in bonds and assuming a 4% withdrawal rate, my bond holdings would cover six years of portfolio withdrawals. On top of that, I’m not even drawing on my portfolio today, because I have enough income coming in to cover my living expenses. That makes me wonder whether I should further reduce my bond holdings and invest more in stocks.

3. I want long-run growth. This, of course, is the reason to own stocks. If your goal is healthy long-run inflation-beating investment gains, stocks remain your best bet—and arguably your only one. And remember, even in a low-inflation environment, retirees most assuredly need growth. At 2% a year, inflation will increase our cost of living by 49% after 20 years.

Through February and March, I aggressively bought stocks, and then saw my portfolio’s stock allocation jump as the market rebounded. That meant I went from 66% stocks at the Feb. 19 peak to today’s 76%.

I readily concede that my current stock allocation will strike some readers as high. But it causes me no sleepless nights. I’m globally diversified and all in index funds, with a tilt toward smaller companies, value stocks and emerging markets.

Some parts of the global stock market will undoubtedly struggle in the decades ahead and most active managers will lag behind the market averages. But because I’m indexed and globally diversified—plus I’m over-weighted in some of the stock market’s least loved sectors—I figure the chances that I’ll suffer atrocious long-run performance are modest.

4. I want to help my kids. I have money in a regular taxable account, traditional retirement accounts and Roth accounts. Once retired, I plan to use my traditional retirement accounts to cover my spending needs and to fund my immediate annuity purchases.

Meanwhile, I hope to keep both my taxable and Roth accounts intact, and then bequeath them to my kids. My Roth accounts are 100% in stocks, and my taxable account is close to it, so I’m hoping the accounts will notch handsome gains between now and whenever I shuffle off this mortal coil.

Congress, alas, has nixed the stretch IRA for most beneficiaries, with the notable exception of a husband or wife. Still, non-spouse beneficiaries have 10 years to empty inherited retirement accounts—which means my children will get 10 years of additional tax-free growth after they inherit my Roths. Meanwhile, my taxable account holds two stock index funds with large capital gains. Ideally, I’d also leave them untouched. Why? Under current rules, a taxable account benefits from the step up in cost basis upon death, thus nixing any embedded capital gains tax bill.

Is all of the above set in stone? Far from it. If interest rates rose, bonds may once again become an attractive source of income. If my health deteriorates, I’d stop the immediate annuity purchases and claim Social Security right away. If retirement proves more expensive than I anticipate—or the markets less generous—I may need to tap my Roth and taxable accounts. But that’s how it is with plans: They give you a broad direction—but you almost always have to make adjustments along the way.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include 15 Ways to Happy, Sunny Prospects and Keep Your Distance.

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David Powell
David Powell
1 year ago

Great piece, Jonathan. If you do write more about the immediate fixed annuities topic I’d love to know how you think about the COLA option. Is it a sensible inflation hedge?

BMORE
BMORE
1 year ago

Thanks for sharing your plan—I am at similar stages of planning. You rebalanced into stocks during the recent correction. This seems wise. What do you think of this approach: at the bottom of the Great Recession in 2008, I shifted 1/4 of my retirement funds from bonds to the lowest Vanguard mutual fund on their list: a large cap value fund had dropped 50%. This nearly doubled in two years, This put me in position to shift back to a broad index fund and enjoy the long bull market. In March, the energy, small cap value funds and one of their historically top active funds had dropped 35 to 45%—did the same. I can’t predict the future, but how do view cautiously picking up relative fund bargains with long range investments? It seems like a good idea, but it isn’t “buy and hold”, which is always recommended?

Sunil Sharma
Sunil Sharma
1 year ago

I presume that your holdings in the two short-term government bond funds are designed to support portfolio withdrawals when stocks are down and it is disadvantageous to sell stocks in order to support portfolio withdrawals. Could you please specify more precisely when you would draw down from these bond holdings and when you would replenish these depleted bond holdings? Do you have triggers in mind that are related to stock market valuation? Thanks.

Steve Chen
Steve Chen
1 year ago

Good article as always Jonathan. A member of our community also committed about 30% of his portfolio to immediate annuities alongside being smart about Social Security to create a retirement income floor. So – that makes two (very smart) people I know who have done this 🙂

He also was strategic about RMDs and his long term investing to hedge inflation. If you want 6,000 words on Glen did and a podcast – read on.

https://www.newretirement.com/retirement/establishing-retirement-income-using-an-income-floor/

HannahKatz
HannahKatz
1 year ago

Your plan looks sound. Curious if your index funds are the traditional kind, or if you are using ESG index funds. Seems like VFTNX outperforms VTSAX over 10, 5 and 3 year windows, and is more tax efficient. Wondering if that will continue as more investors pile into ESG funds.

Jonathan Clements
Jonathan Clements
1 year ago
Reply to  HannahKatz

I just use traditional, capitalization-weighted funds. I have nothing against ESG funds — but any time you stray from a cap-weighted approach, you run the risk of underperforming the market and I’d rather not risk that tracking error.

Roboticus Aquarius
Roboticus Aquarius
1 year ago
Reply to  HannahKatz

This is why it’s hard to make a decision based on historical performance.

When I made the same point, a well-known investor (I was floored) was kind enough to point out to me that VFTNX has a natural tilt towards (Large Cap) Growth (which has done very well over the past ten years.) If you look at the Morningstar style box, the tilt is modest but discernible.

If Value regains the upper-hand for the next decade, for example, this could result in lower returns relative to VTSAX. Whether this will happen or not, nobody knows.

I don’t believe ESG funds are yet terribly effective, but they may be more influential one day. However, they are important to my wife, so we do carry one in our portfolio.

Lee Gesmer
Lee Gesmer
1 year ago

I’ve been debating a TIPS fund for years (I’m age 69). However, as I read about these on Bogleheads (and read, and read … ), there seems to be enormous ambivalence on whether TIPS are a good choice as part of a bond allocation. The argument seems to be that any short-term treasury fund is adequate, and will catch up with inflation in a few years. In othr words, it seems that the BH community is not at all enthusiastic about TIPS.

So, I’ve never pulled the trigger on them.

However, moving some money to Vanguard’s short-term TIPS fund seems to be something of a no brainer – do you agree? That fund will probably mirror short-term treasury, or not deviate from it so much as to be significant. The question though, is how much. I’d appreciate your thoughts on what percentage of a bond allocation should be in short-term TIPS.

Jonathan Clements
Jonathan Clements
1 year ago
Reply to  Lee Gesmer

I have my money divided equally between a fund holding traditional short-term government bonds and the short-term TIPS fund. Is that the right split? I can’t say for sure. But my thought is that one will do well if inflation subsides and interest rates fall, and the other will do better if inflation picks up.

Barbara DuBois
Barbara DuBois
1 year ago

When you swapped your Intermediate-term Inflation index Bond Fund to a Short-term Inflation index bond fund, and the SHort Term corporate Fund with Short term Government fund, Did you incur large Gains or all these funds were in Ira’s?

Jonathan Clements
Jonathan Clements
1 year ago
Reply to  Barbara DuBois

Those funds were in my IRA, so there were no tax consequences.

Steven Crisp
Steven Crisp
1 year ago

Hi Jonathan, I’m in synch with your approach and am wondering if you re willing to share your portfolio specifics in terms of the index funds you hold. Right now I’m in S&P 500 for simplicity, but I too wish to tilt toward small cap and emerging. I also like your logic for using bonds as cash in this low-rate environment, and have been considering the same. Thanks for sharing your approach. It is good food for thought!

Jonathan Clements
Jonathan Clements
1 year ago
Reply to  Steven Crisp

You can find a description of my portfolio here:

https://humbledollar.com/money-guide/my-story-how-i-position-my-portfolio/

I’m reluctant to specify the actual funds I own, because I worry that folks will simply replicate my portfolio, without thinking about whether it’s the right mix for them.

Stephen Valder
Stephen Valder
1 year ago

What role do you see for QLACs in your plan for guaranteed long term income?

Jonathan Clements
Jonathan Clements
1 year ago
Reply to  Stephen Valder

I think deferred income annuities are an intriguing idea, but I don’t plan to use them. Instead, my focus will be on immediate fixed annuities that pay lifetime income.

BCat63
BCat63
1 year ago

Great post and very timely for me personally. Thank you! I am also 57 and my wife and I will FIRE in 2 months. I am intrigued by your plan to purchase a series of immediate fixed annuities over 10 years from multiple insurers beginning at 60. Are you possibly considering a more detailed article specific to the mechanics of that process?

Jonathan Clements
Jonathan Clements
1 year ago
Reply to  BCat63

Glad you liked the article. I’ve had enough questions from readers that I may indeed delve into the topic of immediate fixed annuities more deeply. Thanks for the suggestion.

UofODuck
UofODuck
1 year ago

Have you used a monte carlo tool to get a better feel for the sustainability of your portfolio balance and mix over time? And if so, is there a particular tool that you would care to recommend?

Also, like many of my peers, much of what we have is held in traditional IRA’s. Given my age, I am not a big fan of a Roth conversion as it seems unlikely that we’ll live long enough to “earn” back the lump sum tax we’d have to pay. Any thoughts on how we can shift the balance in favor of our non-IRA assets? Increasing our annual IRA distributions is about the only idea I have.

Jonathan Clements
Jonathan Clements
1 year ago
Reply to  UofODuck

You might check out this calculator from Vanguard:

https://retirementplans.vanguard.com/VGApp/pe/pubeducation/calculators/RetirementNestEggCalc.jsf

I’ve used this and other tools — and the results look fine — but, to be honest, I don’t pay much attention for a simple reason: These tools assume you’re going to carry on spending at a steady pace, no matter what happens in the financial markets, and I just don’t believe that’s realistic. If markets are disastrous, most retirees will instinctively cut back and that improves the odds of their nest egg lasting 30-plus years.

In terms of Roth conversions, it’s a matter of comparing what your tax bracket is today with what your bracket is likely to be later on (or, if you’re planning to bequeath the money, what your heirs’ bracket will be). If the tax arbitrage looks favorable, I would seriously consider converting part of your traditional IRA. It would have the same tax consequences as making larger traditional IRA distributions, but the conversions also get you future tax-free growth.

medhat
medhat
1 year ago

Really intriguing, thank you. Being only a year behind on the age game, I like the comparison to my plan, which I must admit is (much) less structured. Both my wife and I work, me full time (by choice), and for the foreseeable future have expenses like health insurance covered. We’re still making full contributions to our IRAs and through my work a Roth 401k for the same reasons you mention for your kids. But probably the main investing difference is that, for both my wife and I, we’ve lucked into current jobs that, between my full time and my wife’s part time, generate well beyond our current expenses, so why not invest the remainder? I’ve told myself, I’ll quit when I’m bored, but with all honesty I suspect that it’s more likely an unexpected health event, or significant and equally unexpected lifestyle event, would intervene before boredom sets in. In the meantime we both feel exceedingly fortunate to have entered professions we enjoy.

John C
John C
1 year ago

Jonathan your article is a wealth of information and thanks for being so transparent and helping others have a chance to learn from your personal strategy. Part of my plan has been to purchase immediate annuities as well for a portion of my bond portfolio and I am intrigued you are considering starting the process near age 60. The laddering of annuity purchases over the years makes a great deal of sense. In addition to spreading the contracts out over different insurance companies wouldn’t it make sense for most to keep those purchases under a state guarantee fund limit per company if one exists? In California where live it’s $250,000 per insurance carrier if I understand correctly. I have been reading articles written by an academic retirement plan specialist’s who has been making the case how valuable the mortality credits of annuities are during a low interest rate environment. He suggests the insurance companies invest the premiums consumers pay for annuities in bonds so it’s a way to replace a portion of our bond portfolio while generating higher income. Thanks again for providing such great articles all the way back to the time of “Getting Going”.

Jonathan Clements
Jonathan Clements
1 year ago
Reply to  John C

Thanks for the comments. The state guaranty associations are indeed worth considering — and their existence should give comfort to annuity buyers who are worried about “counter-party risk.”

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