I RECENTLY LEFT MY job without having another lined up. Upon quitting, I noticed an immediate mindset shift: I went from thinking about how to grow my money to, instead, thinking about how to preserve it.
As a trained financial planner, I know that many workers will face a similar mental transition as they begin to wind down their careers. But I was surprised at how quickly it happened to me. After all, I’m only age 39, I’m fortunate to have investments and an emergency fund, and I plan to return to work soon.
Here are four questions I’m considering while I’m between jobs. You may find them helpful if you’re considering a career change, a gap year or early retirement.
1. How much money do I really need each month to support myself?
It’s natural to get used to a certain amount of income when you have a stable job—and I’ve enjoyed a steady salary for as long as I’ve been in the workforce. But now that I’m in preservation mode and considering my next steps, I’m wondering how much I actually need to support my lifestyle.
As I see it, there are two ways to answer this question. First, I can approach the question from the perspective of my previous salary. If I assume I spent every dollar of my previous salary except for my documented savings, I can get at that number pretty easily. I just take my old salary and subtract my 401(k) contributions.
This gives me the amount I need to earn to sustain my lifestyle in a new job. For example, take someone who makes $50,000 a year, saves 10% in a 401(k) and socks away another $50 a month in an emergency fund. That person wouldn’t need to replace $50,000 to keep up the same lifestyle, but just $44,400.
The second way to answer the “how much do I need” question is from an expense perspective. Here I would tally up my fixed costs (mortgage, utility bills and so on) and variable costs (entertainment, travel). Then I would gross those numbers up for taxes. If my pre-tax fixed expenses are $1,500 a month, and my variable expenses are another $1,000, I know I need $18,000 a year to cover the former, and $12,000 to cover the latter.
If I’m going to pull that money from a portfolio, I’d need to figure in federal and state income taxes. If those came to 15%, I’d have to pull some $35,294 out of my portfolio to have $30,000 to spend. If I’m going to earn that money through employment, I’ll also need to account for not just income taxes, but also 7.65% in Social Security and Medicare deductions. That means I’d need to earn $38,785 to net me $30,000.
2. To hold me over, can I restructure my portfolio to provide income?
My entire investing career has been oriented toward growth. But I now face an income shortage. Even after I find new work, there’s no guarantee I’ll make the same amount that I did previously. I’m considering whether it makes sense to divert some of my portfolio into income-producing assets. This is a question that many pre-retirees face, so it’s interesting for me to see it up close.
It doesn’t help that interest rates are so low at the moment. My online savings account pays 0.5% a year, which won’t get me very far. Certificates of deposit aren’t offering much more. There are always bonds and dividend stocks to consider.
My friend Ashby Daniels advocates a dividend stock strategy in his easy-to-read book, Creating a Retirement Income Plan Simplified. Investing more in stocks—even dividend-paying stocks—would move me further out on the risk spectrum, and there’s a chance of getting burned. But the idea of scooping up dividends to provide income intrigues me nonetheless.
3. If I sell assets in my portfolio for living expenses, which assets should I sell first?
I have enough savings to hold me over for a while, and this break from work should be short-lived. But you can never be sure what the future holds. What if I enjoy this newfound independence and decide I want to extend it? What if I decide to build my own business? What if I take a lower-paying job?
In all of those scenarios, my cash savings could eventually run out, forcing me to tap into my investment portfolio. Again, this is a question that many retirees face. Do I know which assets to sell and the order in which to sell them? Do I know the tax implications of selling if I need to? From a tax perspective, I’m well diversified across taxable, Roth and traditional retirement accounts. Should I sell taxable investments first? Or consider tapping my Roth contributions?
4. What part-time and “gig” work is available?
I’m only a few weeks into my “funemployment,” and I’m already starting to get antsy. But I’m enjoying the ability to wake up naturally, enjoy a slow cup of coffee in the morning, and take the dog for a walk without having to worry about getting back to my desk.
Rather than return to fulltime work, could I cobble together enough part-time jobs to keep me afloat for a while? If I have an accurate idea of how much income I need each month, I’ll have a starting point as I weigh that possibility.
Matt Trogdon is a financial advisor in Washington, DC, with a special interest in helping Gen X and Gen Y families. He also serves as a workshop instructor for the Babson College Financial Literacy Project. Matt’s previous article was What It Really Costs. Follow him on Twitter @Matt_Trogdon.
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Is a shift towards dividend paying stocks something you would recommend to retirees? I understand the feelings of security one gets from receiving dividends compared to the angst of withdrawing gains, but since I have a fondness for total market indexing, it would seem that the more important drawback to a dividend strategy would be underperforming the total market and ending up with less money. Just curious what your thoughts are there.
I don’t see dividend growth stocks as a substitute for indexing. I see them as a substitute for Bonds, which currently don’t beat inflation and have a risk of capital loss. I have dividend growth stocks (in retirement accounts), as well as indexed portfolios (in taxable accounts). It need not be either/or. Stodgy consumer staples, utilities and companies that have paid uninterrupted growing dividends for decades instead are likely to ensure that my portfolio outlives me in the long run in lieu of the traditional 60/40 portfolio. I have a 75/25 approach. The 25% comprises cash, plus some I-bonds and ultra-short term bonds, to capitalise on a downturn. Having a lot of bond exposure currently adds to long-term risk from inflation.
My dividends grow in the low double digits every year. During the 2020 flash crash, my dividends kept growing.
As Jeremy Siegel recently observed, the best hedges against inflation right now are value and dividend paying stocks with some pricing power (plus some real estate and, maybe, gold), not a 60/40 portfolio with an indexed bond fund.
The brings up the question: what is the optimal age to claim Social Security? The conventional wisdom is to wait until at least 67, preferably 70. That may be best for those who exclusively index, or have a pension to fall back upon.
What it does not take into account is the opportunity cost of tapping into a dividend growth portfolio that compounds at astonishing rates. With dividends that will presumably compound at 8-10 percent when I am retired, I am still weighing the benefits of selling those stocks and interrupting the compounding income instead of tapping into SS at 62.
In the area of finance for retirees, it’s good to consider new ideas – while still being cautiously skeptical. That’s a fancy way of saying “maybe” to the question you asked:
I’m offering a thought. But you should definitely talk with a pro who’s aware of your specifics… for example: Are you at/near the age for taking RMDs?
My Thought:
As always, be skeptical of advice you read on the interwebs. Check with a pro who knows the specifics of your situation.