With so many people not having enough money to retire on, those with retirement assets to draw from are in an enviable position. Yet, this group of people has the unique need to ensure that their retirement sum will last their lifetime. Individuals depending on their personal savings to finance their retirement years need to avoid both spending down their assets too quickly and being unnecessarily frugal in retirement.
Selling around 4 percent of your assets each year in retirement can help make sure that your savings will last the rest of your life. But which investments you sell also plays a role in how long your money will last. Here are three retirement draw-down strategies to consider:
The three-bucket strategy. This approach involves sorting your retirement savings into three buckets: one for long-term growth, one for intermediate needs, and another for short-term expenses. You generally keep your more volatile investments in the long-term bucket, medium-risk assets in the intermediate bucket, and mainly cash in the short-term bucket. In retirement, you will need to periodically move money from the long-term bucket, to the intermediate one, and then to the cash bucket. You can draw money for everyday expenses from the short-term cash bucket.
Since the money in your short-term bucket is held as cash, you do give up potential returns. But you also avoid the disastrous consequences of taking money out of investments that have temporarily suffered major losses. By reducing your risk, you will sleep better at night during bear markets.
Sell what went up. To fund your retirement living expenses, sell the investments that went up in value recently. For example, instead of selling equal portions of bonds and stocks, sell more bonds when bonds had a better year, and vice versa. Bull markets usually last more than a year, so this strategy could potentially limit your gains. But in retirement, capital preservation is more important than growth. And this strategy also has a good chance of limiting the most severe damage that any bubble can cause.
Avoid selling what’s down. It can cause unrecoverable damage when you draw down your assets in a bear market. If your investments lose significant value, even temporarily, the value cannot recover if you withdraw your shares to cover your expenses. Therefore, it is crucial that you limit your withdrawals from investments that are performing below long-term expectations.
One way to accomplish this is to take more out of the market when it's up. Let's say your investments earn 10 percent in a single year. Instead of withdrawing 4 percent, you may decide to withdraw 6, 7, or even 8 percent that year. By doing this, you can skip distributions or withdraw less in down years, which can reduce the damage that an economic crisis can cause to your retirement portfolio.
David Ning runs MoneyNing, a personal finance site that shares money moves you can make to significantly increase your chances of having a comfortable retirement. He likes to share simple changes that anyone can make, such as picking the best online savings account and figuring out whether a 0 percent balance transfer credit card makes sense.