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Financing My Retirement

Copyright © 2010-2017 by David E. Ross

NOTE WELL: I am not a professional investment advisor. Legally, I cannot give investment advice. I am merely describing how I handled my own investments in order to afford retirement.

Investment Philosophy

Portfolio Allocation

Required Minimum Distributions

Social Security

Unisys Pension

Annuities

Assumptions

Leave Some for the Children

But How Much Money Do I Need?

Those Who Lost Less Won

This was the headline for a "Business" section article in the 30 December 2008 Los Angeles Times. The subhead read "In a brutal year on Wall Street, success meant managing not to be totally wiped out."

At the beginning of 2008, the S&P 500 Index was 11.2% higher than it was at the beginning of 2001, an annual growth rate of only 1.5%. During the year 2008, the S&P 500 Index dropped by 38.5%, finishing the year 31.6% lower than it was at the start of 2001. Most individuals saw their retirement savings dwindle even while they added more money. Of course, the stock market was up and down more than once since I started saving for my retirement; and it will be up and down again between now and when I die.

In the meantime, our retirement investments will likely grow less than the S&P 500 Index during a bull market and will likely shrink less during a bear market. This is the result of having a substantial part of the investments in bonds instead of stocks. However, the major part of our investments are indeed in stocks.


The S&P 500 Index grew at a compounded growth rate of 9.39% during 2016. Our retirement savings did worse with a 8.45% compounded growth rate. This reflects my growing emphasis on bonds — which created poor returns in 2016 — in our IRAs. As noted below, however, that emphasis will moderate the growth in fully taxable withdrawals from our IRAs, to be replaced with capital gains withdrawals from our non-IRAs.

The dividends paid on our retirement investments in recent years — excluding capital gains dividends — still exceed what we withdrew to pay our living expenses. Starting in 2015 and continuing in 2016, however, we withdrew more than the dividends. That is, we did withdraw some of our principle in the past two years. I am not concerned about this because it was always my plan to withdraw principle during retirement.

Updated 1 January 2017

Investment Philosophy

Paying for my retirement has not depended on guessing the next stock market trend. Instead, it depends on sticking to a strategy that has no guesswork at all, responding to fluctuations without trying to anticipate them. Thus, I do not engage in market-timing, which only consistently enriches the brokers who collect commissions on both purchases and sales of securities.

There is no secret to my strategy. Anyone who critically reads about investing in the newspapers and news magazines could possibly develop a similar strategy. Since I cannot profit by keeping my strategy secret — and also cannot profit if someone else uses it — I describe it here.

Two columns in Newsweek magazine by Jane Bryant Quinn a few months apart more than 20 years ago strongly influenced my strategy.

Everything else is detail. Here are some of the details.

Heeding Quinn's comment about investing in the market as a whole, I chose Vanguard's Index 500 Fund as my primary stock investment. This choice was somewhat forced upon me when I worked for SAIC, whose 401(k) plan used Vanguard funds. As I read the prospectuses and news items about Vanguard, I recognized that this fund group was not only well-managed but also low-cost. Having a low cost means that more money is left at the end of the year in my account to earn even more for my future.

Some call setting the targets asset allocation. Quinn offered no firm advice on what percentages to use. She merely said that — if you have nothing to drive your choice — 50%-50% is as good as any other ratio. I set my target to a more aggressive ratio of 67% in stocks and 33% in cash and bonds. Some strongly advocate Quinn's 50%-50% ratio at retirement to reduce investment risks, but the striking longevity of my family indicates I will need the added growth from stocks to protect me from long-term inflation. I have gradually adjusted my target ratio to 60%-40% as I grow older as a compromise between reducing my risks and protecting myself from inflation. I may shift more to cash and bonds as I get even older.

The transactions needed to bring your portfolio into alignment with your targets are called rebalancing. In a slowly changing market or when your new investments are significant in proportion to your existing investments, rebalancing can be accomplished merely by changing where you direct those new investments. If there are sharp market fluctuations or when each new investment is very small in proportion to your existing investments, however, you might have to sell stocks to buy enough bonds (or vice versa) to rebalance your portfolio back into its targets. I used to rebalance each weekend although others suggest merely quarterly or even semi-annually. Now I generally rebalance monthly, doing it more frequently only when an investment category is seriously out of balance.

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The California Community Foundation, with an invested endowment of over $1,500,000,000, follows this same strategy with broader ranges allowed for fluctuations before rebalancing.

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I created an Excel spreadsheet to keep track of my investments. If any investment is more than a certain dollar amount or a certain percentage above or below its target, I rebalance. By allowing my investments to fluctuate within some percentage or dollar amount, I buy more of an investment only after it has fallen somewhat and I sell only after it has risen. (No, I will not provide copies of my spreadsheet; it contains too much information relating to my personal finances.)

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This is great advice on Retirement Planning (somewhat dated):

Based on the above, the best current investment advice is to drink heavily and recycle.

Let people you care about know this … and tell them to start now!

Contributed by my daughter-in-law Nancy

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Sticking to this strategy can be difficult. In a falling market, I found myself buying stocks again and again, only to see them lose more value. In a rising market, I was selling my winners, watching them rise some more. But in the end, I found that I was indeed buying low and selling high. As the bear market that started in 2000 roared on, I found that declining stock prices did not delay my retirement. Later, the world-wide recession of 2008-2009 and the resulting severe decline in stock markets did not require any cutback in our spending.

Of course, I maximized my investments in tax-advantaged retirement accounts. I put the maximum allowed by law into my 401(k) plan. I spread that contribution across the year. Making the same dollar investment each payday creates a situation known as dollar averaging. In a fluctuating market, you can obtain a lower average cost (and thus a higher average gain) when you use dollar averaging. (Ask a stock broker or mutual fund about this.)

When Roth IRAs became available, we maximized our investments in those, too. I stopped adding to my conventional IRA when the tax laws changed to deny my deductions for additions. However, I rolled my 401(k) plans from Unisys and SAIC into my IRA; and (when changes in the tax law finally permitted), my wife rolled her 457 plan (similar to a 401(k) but from a government employer) into her IRA. When I retired from TRW, I rolled both my 401(k) plan and the lump-sum settlement of my pension benefit into my IRA. When my wife retired from KinderCare, she too rolled her 401(k) plan into her IRA. Finally, my wife and I have some jointly-owned mutual funds where we invested money beyond what the law allows for tax-advantaged retirement accounts.

Portfolio Allocation

Combining my and my wife's IRAs, Roth IRAs, and joint investments that are not tax-advantaged (what I call our non-IRA joint account), here is a summary of our current asset allocation.

Category%Comments
S&P 500 Index Fund42.15% This is Vanguard's 500 Index Fund, replicating the S&P 500 Index and representing the largest companies operating in the U.S.

While some investment advisors recommend having foreign stocks in a well-diversified portfolio, I noticed that the companies making up the S&P 500 Index are mostly international with very significant penetration into foreign markets and having extensive foreign production and service operations. Thus, this fund provides some of the characteristics of a mix of European, Asian, and developing economies mutual funds while also limiting my exposure to risks from fluctuations in foreign currencies.

Mid-Cap Index Fund11.95% While the large capitalization stocks in the S&P 500 index do represent an overwhelming portion of the total value of U.S. companies, ignoring mid-level capitalization stocks means both omitting a significant investment opportunity and also failing to reflect the overall market for equities. Thus, I have Vanguard's Mid-Cap Index Fund. (Lower-level capitalization stocks represent too small a portion of the total stock market to be meaningful and are too volatile for retirement savings.)
Real Estate6.00% My brother is a strong advocate of investing in real estate. However, I do not want to manage rental properties or pay the high cost of having professional management. More important, I really do not understand the details of what distinguishes good and bad real estate investments. Thus, we invested in Vanguard's REIT Index Fund, which in turn invests in real estate investment trusts. These are REITs that have equity ownership of tenant-occupied real estate and not those that finance or build. The latter can be unstable as indicated by the many that failed in the 1980s when real estate experienced a major bear market.

Taking advantage of a free analysis of our portfolio by Vanguard, we were advised that a "sector fund" such as this should not constitute more than 10% of our total investments in equities. That is because the narrow scope of this fund is not consistent with the need to diversify retirement investments.

Cash2.00% I read that retirees should have a cash reserve sufficient for five years. This allows you to avoid liquidating stocks in a bear market. Our cash is in Vanguard money-market funds, a fund in each IRA, Roth IRA, and non-IRA joint accounts. We also had credit union IRAs that used CDs and savings accounts, but the credit union required too much bureaucratic paper work for each IRA withdrawal.

We setup our mutual fund accounts to pay all dividends into the Vanguard Prime Money Market Fund within that account. Besides meeting our cash-flow requirements, this creates a source of money for rebalancing other funds, thus avoiding restrictions imposed by Vanguard to prevent market-timing transactions.

By itself, this fund provides only a cash reserve sufficient for 9 months. However, our cash reserve also includes the Intermediate-Term Bonds category, which gives us funds sufficient for 11 years.

Intermediate-Term Bonds30.40% This is invested in Vanguard's Intermediate-Term Investment-Grade Bond Fund. In 2012, I reduced this allocation slightly in anticipation that Federal Reserve System will eventually stop its program of artificially keeping interest rates low. Now that interest rates are beginning to rise and the per-share value of this fund falls, I am restoring the investment to this allocation percentage.
Long-Term Bonds7.50% Often, long-term bonds move in opposition to stocks. This tends to reduce the magnitude of fluctuations in our overall portfolio. We use Vanguard's Long-Term Corporate Fund.

My concern that future increases in interest rates would cause a decline in the value of bonds (see Intermediate-Term Bonds above) did not cause me to reduce the allocation to this category. The relatively small amount invested here would not cause significant harm to the overall portfolio in that event. Also, the long-term expectation for my retirement means that a higher interest rate will eventually translate into greater earnings from this fund, offsetting much of the decline in the values of the fund's bond holdings.

These are the target percentages in effect on 1 January 2017, not the actual percentages.

The current chart reflects a gradual trend to a more conservative investment philosophy through an increase in bonds and a decrease in equities. Such a trend is appropriate as my wife and I get older. Currently, withdrawals from these investments provide 45% of our cash needs.

Required Minimum Distributions

In the U.S. Internal Revenue Code, there are differences between an IRA (Individual Retirement Arrangement) and a Roth IRA.

On advice from Vanguard relative to RMDs, I am reallocating investments between our IRAs and Roth IRAs. To ensure sufficient cash-flow to make the RMD withdrawals and to reduce growth, I am increasing the emphasis on bond funds in our IRAs. Bonds provide a steady stream of dividends but are not considered growth securities; the latter is important to reduce the impact on RMDs from investment growth. To promote overall growth in our retirement investments and maintain the allocations shown in the chart, I am increasing the emphasis on stock funds in our Roth IRAs. To accomplish this, I move money from stock funds to bond funds in our IRAs while moving the same amount of money from bond funds to stock funds in our Roth IRAs.

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I have heard that paying for retirement is much like a three-legged stool. You depend on:

I have all three. However, many companies are removing one leg of the stool by eliminating their defined-benefit plans; and Republicans in Congress would like to remove another leg by eliminating Social Security in favor of the third leg (savings and investments).

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Social Security

First of all, despite my positive experience with planning my own investments, I most definitely oppose privatizing Social Security or allowing individuals to substitute stock market investments for their Social Security accounts. Indeed, my investments prove that the current Social Security program does not inhibit individuals from investing towards their retirements. In the meantime, I appreciate that my Social Security benefits will not deteriorate during a bear market and will not be affected by the next Enron, WorldCom, Lehmann Brothers, or AIG collapse. After all, the stock market recently experienced nine years (2001-2009) of negative investment returns.

In our retirement, Social Security (net of withholding for Medicare) currently provides 41% our cash needs, almost as much as our retirement investments. The amount reflects delaying the start of my benefits until Evelyn retired (between my 64th and 65th birthday). (The standard retirement age for someone born in 1941 is 65 years and 8 months.) My decision to delay my Social Security benefit (instead of starting at age 62) was influenced by software I downloaded from the Social Security Administration (SSA) Web site. Unlike benefit estimates prepared by the SSA, this software allows the user to tailor the calculations to meet his or her personal situation. For example, the software allowed me to compute my benefits with the assumption that I retired in 2003 but delayed my benefits until 2006. The software's computations even took into consideration projections of inflation. On the other hand, benefit estimates from the SSA always assume that the individual works until the day before starting benefits and that there is no inflation.

Unisys Pension

Unlike my TRW retirement benefit, my Unisys pension plan did not allow for a lump-sum payout. I have to take monthly annuity payments. Because I was not yet 55 when I left Unisys after 24 years, my normal retirement age under the pension plan was 65. (It would have been 62 if I had not left to work at SAIC and stayed at Unisys — without being laid-off — for three more years.) By starting my Unisys pension early, I lost 0.5% for every month before my 65th birthday. Thus, starting the pension in January 2004, I lost 15%. My spreadsheets indicate that the loss is more than offset by reducing the draw on my retirement investments (just as with starting Social Security benefits at age 64.5 instead of waiting another 14 months). The pension is not a large amount, providing 14% of our cash needs.

Annuities

Solicitations for me to purchase an annuity are frequent in my life now that I am retired. An annuity is a contract with a financial institution (e.g., insurance company, mutual fund) to pay me a fixed amount of money periodically (monthly, quarterly, or annually). The payments might be for the rest of my life or — at a lower amount — for the rest of the life of my wife or me, whoever lives the longest. Alternatively, the payments might be for a fixed number of years. An annuity might be adjusted annually for inflation. The payments might fluctuate with the stock market.

My Unisys pension is a form of constant annuity without any inflation adjustment, unchanging as the stock market changes. To cover my wife in case I die first, it has a survivor's benefit of two-thirds of my current benefit. For this, my own benefit was slightly reduced; but I will continue to receive my current benefit if I survive my wife.

There are good features about a life-time annuity with inflation adjustments:

There are also disadvantages:

My wife and I do not have any annuities.

Assumptions

I retired when my spreadsheet projected that our money would last beyond my 95th birthday. This spreadsheet includes the following assumptions about inflation and the rate of return on our investments:

Note that, with local inflation usually greater than national inflation, Social Security will not keep up with my cost-of-living. Furthermore, my pension from Unisys is constant, without any inflation adjustments. Thus, the spreadsheet assumes that we will use both investment earnings and the principal. With these assumptions, we can meet our cash needs beyond what Social Security and my Unisys pension provide. Actually, we have been underspending what I projected we would withdraw from our investments; thus, we have not yet touched our principal (as noted earlier).

Leave Some for the Children

The real issue is "How large an investment do you need to retire?" We have enough that, after adding in my Unisys pension and Social Security, our retirement savings will last into my late 90s. My ancestry is very long-lived, and I had to plan for a retirement that might last more than 30 years. One factor about which few individuals think (because its morbid) is that every year you delay retirement, you gain two years advantage in paying for it: You have one additional year accumulating savings, pension benefits, and Social Security benefits; and (the morbid part) you have one less year in which to spend that money.

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Our son died in 2013. His share of our estate will go to his son, our grandson.

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While our children should inherit our house and personal possessions, there may be little in the way of money (other than life insurance to pay our final bills). We love our children dearly. They are really very good individuals — intelligent, caring, with high standards of integrity, and good senses of humor. Yes, we worry about them; otherwise, what kind of parents would we be. However, they are adults who can take care of themselves. They really do not need us to leave them anything other than their good characters and the memories of our love. In any case, our recently revised estate plan leaves all our remaining retirement investments to our grandchildren.

The final answer is that you really do not need enough savings that you use only the earnings, which would have required prolonging the commute from Hell because I would have had to work longer in order to accumulate the additional investments and pension benefits. Of course, I would then have fewer years in which to enjoy retirement. Instead, my plan involves using a realistic projection of my life-span and then taking just a little longer to deplete my resources. Nevertheless, my wife and I do have a comprehensive estate plan.

Of course, long-term financial projections — 20 years or more into the future — cannot be accurate. Even slight changes in inflation or return on investments can result in significant changes in projections of how long my retirement savings will last.

But How Much Money Do I Need?

The dollar amount is really none of your business. That is why I will not share my spreadsheets, in which I have embedded some dollar amounts. However, I do not object to sharing my approach to determining that amount.

Originally, I took our combined income as a starting point. I subtracted what we were saving for retirement — 401(k) plans, Roth IRAs, and investments not tax-advantaged — because that cash outgo would stop upon retirement. I then took 75% of the result. After all, you can live retired more cheaply than living employed. For example, commuting and lunch costs can be significant in a year's time. Also, by being careful which investments are liquidated first, taxable income can be significantly reduced (having already eliminated taxable salary). (On the other hand, when you are retired, you might increase your attention to hobbies, some of which can be quite expensive.)

The problem with this approach was that my bonuses and my wife's overtime unpredictably perturbed our combined income. The resulting estimate of cash needs for retirement exceeded what I think is needed even for a couple that is not retired. Our needs are not great. We finished paying our mortgage in 2000. We do not buy a new car until the old one truly needs replacement, and then we do not buy luxury vehicles. We do not wear the latest fashions or eat in the trendiest restaurants. While we do spend more freely now, the habits of frugality that we adopted when I was unemployed are still with us.

In the end, I chose an absolute dollar figure for cash needs that is still higher than the incomes of most American families. In my spreadsheet, I adjust that figure at the beginning of each year based on the prior year's actual experience. For later years in the spreadsheet, that figure increases by my estimate for inflation.

Updated 1 January 2017


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