Monday, December 24, 2007

How do I withdraw from the retirement portfolio?

I have read many books that talk about building up a portfolio, but few actually teaches how to withdraw from a retirement portfolio.

Withdrawing from the portfolio is as easy as just adjusting your asset allocation. Some people advocate equities investing forever. However, there is one crucial point to take note. Equities investing is volatile. Look at the markets for the past few months and you'll see the effects. Going up and down 1000 points is very common for the major markets like HSI and DJIA for the past few months. After the great depression in 1929, the markets stayed down for 10 years. If you're 90% in equities and you retire in 1929, you may find that your retirement funds might not outlast you. Some people might say that the great depression will never happen again, but what happens if it does?

That doesn't mean though that you should be totally out of equities. Books that I have read talk about 20% to 30% in equities. Shifting the allocation is also quite simple. Assuming you have a portfolio of 70% equities, 30% bonds. In general, 5 years before your "retirement", you will start to shift your allocation more towards bonds. Assuming you wish to retire at 55:

Age 51: 60% equities, 40% bonds
Age 52: 50% equities, 50% bonds
Age 53: 40% equities, 60% bonds
Age 54: 30% equities, 70% bonds
Age 55: 20% equities, 80% bonds

Formula for shifting the allocation per year will be something like: (Equities allocation - 20%) / 5 years.

Why 5 years? That's because we'll never know when Mr Market is feeling well or unwell. Therefore, by sticking to the asset allocation and gradually moving towards the retirement asset allocation, we will still be selling high and buying low, and the retirement portfolio will still be growing. When you retire, it doesn't mean that you will withdraw all the money from the portfolio and start spending. It's always best if the retirement portfolio is still generating returns for you as you withdraw from it. In that way, it will last longer and it will have a higher chance of outlasting you.

Still using the example above, you will have 80% of bonds now. The question would be more like can this 80% bonds generate enough income for you to live for the rest of your life. If it does, congratulations. Your retirement will be carefree and you can enjoy life. :)

However if it doesn't, then it gets a little tricky. That means you will have to draw down your retirement portfolio while still keeping to your asset allocation. Still using the example of 20% equities and 80% bonds, you might want to withdraw 5% from equities and 5% from bonds into a money market fund. Note that your asset allocation is still 20% equities, 80% bonds.

After which, you withdraw your retirement income from the money market fund. This is assuming that the 10% you have withdrawn from the portfolio is enough to last you for 6 months. If its too little, or too much, adjust the % withdrawn accordingly. The lesser you withdraw from the retirement portfolio, the longer your retirement portfolio will last. Once the funds in the money market fund is getting low, just withdraw 6 months of income again.

Reason for withdrawing only 6 months of income is that you will want the retirement income to last as long as possible. By withdrawing as little as possible from the retirement portfolio, your portfolio is still able to generate returns for you, thus ensuring that the portfolio will outlast you.

There are of course many other ways of withdrawing from the retirement funds. The above example I feel though is the safest. Once we reach retirement age, I don't think we will want a heart attack whenever the market goes up and down. Simple philosophy in life is that we work to live, not live to work.

This "last post" sort of summarizes most of what I have read about retirement planning. I still do read books every now and then and will add on to this retirement planning topic as and when I read something interesting. Just to clarify again that these posts sort of summarizes everything I have read in the books. Thought that it might be interesting to some people so I "pen it down" here for all to see.

If you have other ideas, feel free to leave a comment. We can always have a healthy discussion. :)

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