Our cash was running low. It had been a year and a half since I sold significant assets. Last month, when I added up our liquid reserves, they were down to about six months of living expenses. For many a young worker that would be a cushy emergency fund. But for me — an early retiree now approaching his 60’s — that six-month margin set the alarm bells ringing.
I’ll admit, the fear isn’t entirely rational. We have a substantial and well-diversified portfolio. It’s very unlikely that we’d encounter a market scenario where I couldn’t sell at least some of our bonds, stocks, or commodities at a profit. My research into an optimal CAPE withdrawal strategy implies as much. According to my mathematical simulations, I could just wait until we actually need cash, then sell whatever is in favor.
But that need to sell is worrisome to me. I lived through Black Monday in 1987, the Dot-Com crash around 2000, and the Great Recession of 2008-2009. I’ve seen waves of panic selling. People sacrificing their savings and their future to raw emotion. While there were undoubtedly some assets that profited during those times, do I really want to gamble that I’ll be holding the right ones when the need arises? Do I really want to stake my retirement security on the availability of willing buyers in a crisis?
I’ve seen enough of panic selling from the sidelines, and I don’t ever want to be forced into that desperate crowd. I want to be secure in my cash position before the bad news hits, flush enough to pay my bills for years, able to shop for bargains, perhaps, when the dust clears.
As the saying goes, in a financial emergency, “Cash is king.”
And so I raised some cash this month. Far in advance of any need or urgency. Perhaps I’m overly cautious. But that same abundance of caution has served me well over my financial life. So here’s what I did, and how, and why….
Why We Still Aren’t Buying Annuities
Regular readers here might be disappointed that I still don’t have a consistent personal “system” in place for withdrawing retirement income. I’m an engineer, after all. I prefer to solve my problems once and for all, by automating a solution. It would be very appealing to simply have a retirement “paycheck” show up every month, on autopilot, no human intervention or decisions required. And that’s my long-term goal. But the reality is that I’m not there yet.
The simplest way to create a retirement income system is with annuities. But, for a variety of reasons, we aren’t ready to pull the trigger on an annuity yet:
For starters, interest rates are still near historic lows. Not only does that reduce the payouts on annuities right now, but it presents risk for future payments. There is a high probability that interest rates and inflation will rise at some point in the coming years. That will reduce the value of any fixed annuity payments. The money simply won’t go as far toward living expenses in an inflated world as it once did. The obvious solution — an inflation-adjusted annuity — is expensive, complex, and harder to find. Other than Social Security — which has its own problems — there is no simple solution right now for most of us to obtain long-term, economical, reliable, inflation-adjusted income.
So, while it seems to offer safety and convenience, we just don’t feel we can afford to convert our retirement nest egg into an annuity payment, yet. Instead, we need to accept ongoing market and lifestyle risk for at least the rest of our 50’s. That’s the best bet to grow our nest egg and go annuity shopping in our 60’s to ensure our assets will last to the end of our days.
If, as is most likely, the market outpaces inflation over the long haul, our standard of living will improve by keeping our nest egg invested in stocks and bonds now. But if, as could also well happen, there comes a decades-long downturn, we will have to make cuts in our lifestyle.
Why It’s Hard to Standardize Retirement Withdrawals
Despite all the academic research into general algorithms for performing retirement withdrawals, the way that you implement such a system is always going to be highly personal. Why? Because your resources, constraints, schedule, and environment are unique to you. And those are all key inputs to each withdrawal decision….
In our case, we hold a specific set of funds in an asset allocation unique to us. Our cash burn rate is also unique and variable, depending on what has been going on in our lives that year. Our history of investment performance and my view on market valuations going forward are unique to me. Finally, my and my wife’s personal ability and interest in managing investment complexity uniquely constrains our withdrawal strategy.
To be blunt, for us, simplicity trumps getting every last dollar off the table.
If you deal with a financial advisor, or read the press, you might have a different experience. You’ll get a prescribed withdrawal system, but it may or may not fit your situation well. How much time will the average advisor spend with you? Maybe you’ll have a quarterly meeting. It will probably be a few hours a year, at best. How well can they really understand your situation given a limited time commitment?
In the end, you may wind up with a one-size-fits-all system for retirement income. I recently heard an interview with an advisor who had a one-page system for doing retirement withdrawals, based on respected but generally available research. He was highly confident in this system and charged clients thousands of dollars a year to implement it for them. Was it correct or optimal?
Who knows? There are hundreds of studies and dozens of systems for doing retirement withdrawals. Almost any system an advisor recommends is going to have “guardrails” built in. So if the market goes down too much they will recommend you cut your lifestyle. That eliminates the risk to them that you run out of money, but increases your risk of living a sub optimal lifestyle. You’re paying the fees and taking the risk, either way.
I’d rather make the judgment calls, the trade-offs, and the sacrifices on my own, without the financial overhead, thank you!
When to Sell: Assessing Tax Brackets
Sadly, I can’t offer a strict schedule for making retirement withdrawals, but I can tell you the reality of what has been working over the six years of my early retirement. I tend to evaluate our cash holdings twice each year: once in early January, and again in late summer. To go through this thought process more often would feel chaotic and unnecessary. It doesn’t deserve constant attention. But to do so less often would feel risky: we could be blindsided by an economic downturn, without enough cash on hand.
Are there other important constraints on selling assets for retirement cash flow? Yes there is a big one: taxes. I always estimate my tax liability for the year before proceeding to sell assets and possibly generating taxable capital gains. It’s important to evaluate my tax rate before and after any potential sales, so I don’t blunder into a needlessly high tax bill.
My current favorite tool for that job is the TurboTax TaxCaster app. It runs in a browser or on a smartphone, is updated annually, and collects just the right amount and type of data — personal information, your income, and your tax breaks. Assuming you’ve got that input data at your fingertips, you’ll get a reasonably accurate estimate of your taxes, without investing more than about 15 minutes. Importantly, TaxCaster computes your Taxable Income and Marginal Tax Rate. And those are critical numbers for tax planning in any given year.
Since we live a relatively frugal retirement lifestyle, we normally have the option to sell assets while in the lower two tax brackets (10% or 15%). That means we pay a 0% rate on our long-term capital gains. That’s right, zero, nada, in taxes. It’s a special gift from the IRS to long-term, lower-income investors like us.
However, I have to keep an eye on our overall Taxable Income to ensure that favorable treatment. This year, for those of us married filing jointly, you can generate up to about $75K in taxable income before moving into the next higher bracket. Once there, you’d be taxed at a higher rate and taxes would be levied on your long-term capital gains. TaxCaster makes it easy to monitor your tax liability throughout the year.
What to Sell
Once I’ve identified that our cash reserves are low in one of my twice-yearly checkups, and once I’ve verified the tax implications of selling, I have to decide exactly which investments to sell from my portfolio. This gets easier and easier each year as I simplify my holdings. Ten years from now I expect to own a single balanced fund. And the liquidation decision will be easy: Sell some of that.
But, as of now, I still have about a half-dozen holdings. Which to sell?
Well, I can eliminate about half of them because they are held in tax-sheltered retirement accounts and I’ve yet to reach age 59-½. Of the remaining positions, two are balanced funds that I intend to keep for our end game. So I will avoid drawing from them any time soon. That leaves just two candidates for liquidation this year: SPDR Gold Shares (GLD) and Vanguard Total International Stock Index (VXUS).
Fortunately, I can sell either of these for a profit. I’ve owned the GLD for almost a decade, during which the price has risen nearly 50%. And international stocks have had a good recent run, rising almost 20% in the past year. That performance meant I was over-weighted anyway in both positions versus my target allocations. I aim for about 5% in gold, but was closer to 7%. And I aim for about 30% international stocks, but was closer to 40%. Further fuel for a “sell” decision.
The last thing I considered before pulling the trigger in my brokerage account was my CAPE withdrawal strategy….
“CAPE” is Robert Shiller’s Cyclically Adjusted Price-to-Earnings ratio — defined as the price of the S&P 500 divided by the average of the last ten years earnings, adjusted for inflation. There are endless arguments around stock valuation metrics, market timing, and simulation parameters. But, all things being equal, I have come to believe that I will do better in the long run if I can sell stocks when CAPE is high, and sell bonds when CAPE is low.
Looking at the CAPE right now we see that it has been exceeded during only one other period in all of stock market history. So we are in nosebleed territory for stocks by this measure. That makes the decision to sell international stocks, and hang onto my bond and balanced funds now, even easier.
Two Years of Security
In theory, I could apply a withdrawal strategy monthly, to keep my investments growing longer. I would just sell as I needed the cash for living expenses. But, that doesn’t work for me emotionally.
I get anxious when my cash reserves dip under one year. And, as I indicated at the start, I get downright queasy when they drop below a six months’ supply.
I won’t be forced to sell in a market downturn. I won’t pin my ability to eat and pay bills on the hope of owning uncorrelated assets that I can sell to another buyer in a pinch. Cash has always been king in times of extreme economic stress, and I suspect that reality will remain.
So, as I write this, our coffers are once again full with about two years of living expenses in cash. I can now return to ignoring the market news and fluctuations for a while, not worrying about what the future will bring.
By our mid-60’s I hope to have a true retirement income system in place. It will be based on annuities and balanced funds that eliminate any need for timing decisions. But, due to our early retirement and the current economic cycle, it’s too early to implement such a system now. What I’ve described above is the best I’ve got….