How are you supposed to invest after you stop working?
Retirees used to think that question had a one-word answer: bonds. And a one-rule strategy: Never spend principal. But with retirements lasting decades, those one-size answers no longer fit all.
The task of figuring out how much to spend in retirement and how to invest to produce that cash flow is part art, part science, and completely daunting. Many people who have been putting aside money for most of their working lives have a very tough time transitioning to that time when it's OK to stop saving and start spending.
"It's a very difficult thing for people to prepare for," Tony Proctor, a Wellesley, Massachusetts, financial planner who has devised a cash management system for his retired and near-retirement clients.
Emphasizing the timing of their expenses, he tries to break clients of the belief that they are past the stage of investing for growth or that they will spend the same amount, year in and year out, once they are retired.
Proctor forces his clients through intensive expense planning. He has them put enough money into bonds, money funds, and other safe investments to fund five full years of spending. He then invests the rest in a broad mix of foreign, domestic, large- and small-company stock funds.
When the stock market is strong, he replenishes the spending money by selling shares of the stock funds that have done the best. When the market is down, he has the clients draw down their spending fund to avoid selling stocks at low prices. He "pays" them through automatic deposit into a checking account, so that they don't spend too much time worrying about strategies and withdrawals.
Proctor's approach reflects much of the most current thinking on retirement spending and investing. Here are some of the newest rules and how to make them work for your retirement plan.
Timing is everything
If you start pulling money out of your retirement accounts when the stock market is behaving bearishly, that can cost you for the rest of your life. Even a one-month difference in when you start withdrawals can change the amount of money you end up with by 10 percent or more, according to academic research.
If the market is going gangbusters and you're within five years of retirement, that's probably a good time to start pulling some money out of stocks and putting it into bonds, certificates of deposit, or money funds so it will be there when you are ready for it. Timing your withdrawals in this way also protects you from keeping too much money in the most bid-up of investments.
Expect your expenses during retirement to be higher at some points than at others
The first few years of retirement (and the last year or two leading up to it) are extremely expensive. People buy second homes, take big trips, redo their houses and their wardrobes, and outfit those hobbies they finally have time to pursue. But they also spend less on work clothes, commuting, and lunch out.
As the years ago by, they'll pay down mortgages, stop traveling so much and spend less. By the time they are 80, their biggest expenses are housing and health care, and they typically are spending far less than they were at 65 or 70.
But retirees have occasional big expenses, too: They will buy new cars, write big checks for their grandchildren's tuition, and the like.
The moral of the story? Forget rules of thumb about how much you'll spend. Really look at your life and try to guesstimate what you will spend. Assume that number will change from one year to the next.
There is a safe withdrawal rate, but it may be too safe
A lot of computing power has gone into this rule of thumb: If you want your money to last forever, don't take out more than 4 percent of it a year.
That's true, but extremely conservative, Proctor says, since only people who are around 50 have to manage their money so it will last forever. If you haven't started to withdraw money from your retirement funds until you are 65 or 70, you can probably afford to take out between 5 percent and 6 percent a year. If it looks like you're spending your money too fast, you can always tighten your belt a little bit.
Stocks are good
Because of those long retirements, you can no longer count on bonds and bank accounts seeing you through. You have to continue investing for the inflation-beating growth that stocks and stock mutual funds deliver.