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Ben Carlson’s column today is a reprint of a method for sustainable retirement spending. You start by calculating your spending requirements in retirement (although I don’t see an allowance for inflation) and have four year’s worth set aside in cash or cash equivalents by the time you retire. Then there are rules for when you withdraw from cash or stock, and when you replenish cash. It sounds like the remainder of the portfolio is all in stock. I didn’t follow that method, as I only have 50% of my portfolio in stock, but it is an interesting approach, and worked for him, despite starting retirement in early 2000.
Thanks Kathy. I just read Ben’s article. Noting the story isn’t his own experience but that of a friend and fellow financial writer John, most of the post is actually John’s words, including the below (bold is in the original):
“Please note that what I say below is based on the following two key assumptions about the stock market.
As John says, these are important assumptions. Also, what about sideways markets? These can last a lot longer, though the impact of selling in them is much less. I don’t care to do the math, but I know personally want more of a buffer than four years.
To each their own. Still a useful piece, the important message in which is having “enough” cash.
AAII has an article (membership might be required) that expands upon this strategy, emphasizing the primary objective of preventing forced selling of equities during down markets to generate cash for spending.
The strategy is structured as follows:
1. Establish a “Safe Bucket” with 3–4 years of planned withdrawals before retirement.
2. Maintain the rest of your portfolio fully invested in equities.
3. On a yearly basis (designated as a “decision day”), assess the market conditions.
4. Compare the S&P 500 level to its all-time high.
If the index falls by more than x% (adjust the threshold based on your preferences), that year is considered a down year.
5. In normal (upward or stable) years, withdraw funds from your equity portfolio. Refill the safe bucket to 4 years’ worth of spending (as outlined below in 7).
6. In down years, withdraw funds only from the safe bucket. Avoid selling equities during the downturn and maintain a defensive stance until the market recovers.
7. Rebuild the safe bucket gradually after recovery. Accumulate half of the shortfall each year for two years. Pause rebuilding if another downturn occurs.
There is also a three bucket portfolio designed by Bill Bengen. 1-2 years of cash needed to top off any income above Social Security, annuity or pension to meet annual spending needs. The balance up to a total of 10 years in short term bonds. Finally any left over dollars in equities. Refill each bucket unless the market is down, instead spending from cash first, then if necessary from bonds. The reasoning is that the majority of down markets recover within a decade.
Should we assume “holding 4 years of expected expenses in cash” would mean expenses over and above Social Security and annuity etc. Is that right?
Yes, that’s right.
I read Jane Bryant Quinn’s book “How to Make Your Money Last” 2-3 years before retiring. One of her central tenets was holding 4 years of expected expenses in cash in a “bucket” if I recall to weather any potential severe market downturn to help one sleep well at night. At the time Jane mentioned that most severe market declines historically didn’t not last longer than 4 years (I’m sure there are exceptions). I would include some inflation factor on those 4 years (she may have mentioned this as well- I last read the book about 8-9 years ago). Ben Carlson’s article seems to be a rehash of her approach to holding a set # of years in cash/CDs/ST T-Bills, via a bucket approach which Jane advocated. I do hold a minimum of 4 years expenses in Cash/ST fixed income. The cash bucket is meant to be a holding within ones overall fixed income allocation.
If you have not read this book, it’s worth a read (for pre/early retirees) even though it’s a bit dated (appears a second edition came out in 2020).
Kathy, thanks for pointing out Carlson’s post. I agree with the author’s approach and his conclusion, that it is better to keep a cash reserve of actual living expenses, rather than a rule-of-thumb figure. It’s essentially the same advice that Jonathan gave many times, to hold about five years’ worth of expenses in cash or cash equivalents, like short-term government bonds.
I suppose I am doing a version of it, as I have a five year CD ladder. I just have bonds as well as stock in addition.