Approaching Retirement

I adapted this from What Should You Do?

You are approaching retirement. You haven't thought through your finances. What should you do?

The Critical First Step

There is one thing that you absolutely MUST do immediately. Do not delay. Follow John Bogle's advice: Do nothing.

Investment Baseline

Now that you have passed the emergency stage, you need a baseline. This is a PAPER baseline.

Look at the TIPS Table (button on the left). See how much you can withdraw and how long.

You never have to accept a retirement approach inferior to a portfolio consisting entirely of TIPS and/or ibonds.

Expense Baseline

You need to estimate your retirement needs.

The wrong way to do this is to base your retirement income requirements on your working income.

The right way to do this is to base your retirement income requirements on your expenses. The most important expense that you are likely to overlook is HEALTH INSURANCE. It is an important expense. It is a rapidly growing expense.

Some expenses disappear, such as Social Security deposits. Many other expenses decrease. Your automotive expenses are likely to decline sharply. Even if you travel a lot, you will not be driving to work every day and under all conditions.

Take Deliberate Steps

Remember how you got to where you are.

If you have invested in real estate, you will probably do well to keep investing in real estate. If you have invested in stocks, you can probably do well continuing to hold stocks. If you have invested in mutual funds, you are likely to do well continuing to hold mutual funds.

Your experience helps you know how you react to investments. Reading about stock market fluctuations is not the same as owning stocks while living through stock market fluctuations.

Your experience helps you avoid serious mistakes. Your lack of experience as you move into a new area can cost you dearly. There are many investment products with very short histories. They sound great. Some are great. Many will fail. The history of the financial markets is littered with great investment products that failed.

Some of My Findings

I have identified three good approaches:

1) A portfolio consisting entirely of TIPS (and/or ibonds).
2) A portfolio that varies allocations between stocks and TIPS gradually, according to valuations as measured by Professor Robert Shiller’s P/E10. You can determine P/E10 if you know the S&P500 index level. Use the Stock Returns Predictor (button on left).
3) A dividend-based strategy.

You can combine these approaches.

Our baseline portfolios of TIPS and/or ibonds are powerful baselines. Very few approaches do better. Traditional, fixed allocation approaches often do worse.

Two decades of a bull market in stocks have caused people to forget the advice of Benjamin Graham to allocate no less than 25% and no more than 75% to either stocks or bonds. [This is for a portfolio of stocks and bonds.]

Take heed of Benjamin Graham’s suggestion. What if the stock market were to increase by 30% or 40% in the year right after you had bought your TIPS? How would you feel? What would you do? The stock market rises about half of the time during bear markets. Large, single-year advances are common even in bear markets.

I have calculated optimal switching algorithms with stocks and TIPS. I have included them in the 30 Year SWR and 15 Year SWR Risk Evaluators. You can learn to do even better by training on the Scenario Surfer.

Dividend-based strategies are inherently sound. The key is the quality of the dividend. This depends on having sufficient earnings (smoothed over several years) to cover payments.

I like combining high yield investments (often with limited dividend growth) with investments with a lower initial yield but with rapidly growing dividend amounts. The higher yielding investments allow you to withdraw more during the early years. Excess income in the first few years makes up the deficit during the middle years. The dividend growth investments meet your income needs in the later years.

Have fun.

John Walter Russell
January 21, 2008

What Should You Do?
What Should You Do: Addendum?