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Cash Flow in Retirement
(Updated 9/30/06)
Bob Brinker’s Retirement Portfolio I am a subscriber to David Korn’s weekly newsletter. ( See note 1 ) David closely follows the stock market, the economy and investments in general. Plus, he interprets Bob Brinker’s radio program, Moneytalk. I got the idea for this article from reading one of David’s interpretations of Bob Brinker’s program. A caller to Brinker’s show needed to start withdrawing from her portfolio. The caller heard that 4% was a prudent number and wanted Brinker’s advice. ( See note 2 for articles examining the 4% historical withdrawal rate.) Here is David’s interpretation of that call:
This leaves the question of how to extract the remaining 0.7% for the annual withdrawal. Another question is whether Brinker considers having the annual withdrawal increase each year to account for inflation in order to maintain purchasing power. Most withdrawal studies do assume that the annual withdrawal will increase each year for inflation. The likely answer to the question of how to withdraw the remaining 0.7% would be to sell appreciated shares from the stock market index fund. However, this assumes that the market had risen during the year. I guess this is a given during periods when Brinker has already given the signal to be in the market. But what about when Brinker gives the signal for getting out of stocks? It's unclear how Brinker would continue withdrawing 4% during a bear market. Back in early 2000, Brinker advised placing the proceeds from stock sales into money market accounts. The reason presumably was to protect those stock market cash reserves from fluctuation. However in a bear market, it is questionable whether money market interest will generate sufficient cash flow. Remember that a bear market often signals weakness ahead for the economy. Under recessionary conditions, the Fed, in order to stimulate the economy, will likely be lowering short-term rates. This will leave a skimpy yield being generated from money markets. While likely not something Brinker would recommend, a retiree could transfer her stock market holdings into Ginnie Maes. And then from the Ginnie Mae interest, the retiree would be able to withdraw her 4%. However, there would be some fluctuation to principal. ( See note 3 ) This strategy relies on correctly calling the direction of the stock market. In other words, to sell appreciated stock fund shares during bull markets. And then side-stepping bear markets and earn Ginnie Mae interest. Calling the direction of the stock market is something that not only Bob Brinker aims to do. But David Korn and his guest contributors have studied, as well. ( See note 4 ) Substituting DVY However, there may be a way to slightly modify this strategy without having to switch money around between stocks and Ginnie Maes. Instead of using the Total Stock Market index or an S&P 500 fund, a retiree could own a fund that generates a higher dividend yield. One such fund is an exchange traded fund (ETF) called DVY. This fund has a dividend yield of around 3%. Click HERE. So with half the retirement portfolio in Ginnie Maes, a retiree would be able to take 2.5% from the interest generated (5% yield divided by 2). And with the other half in DVY, she would be able to withdraw 1.5% from the dividends (3% yield divided by 2). Together, she would be able to withdraw 4%. Over the years, DVY should appreciate in a manner similar to the Total Stock Market index or the S&P 500 fund. And from this appreciation, the nest egg should grow modestly. The retiree would then be able to withdraw larger amounts in future years. And hopefully, these larger withdrawals will maintain purchasing power to offset inflation. A 50/50 portfolio of DVY and Ginnie Maes is both simple and will probably get the job done. However, to assure success, it is helpful to add different stock funds in order to be more diversified. ( See note 5 ) In contrast, some investors feel that simplicity is of greater importance and want stick with a single stock fund. Just keep in mind that the Total Stock Market and the S&P 500 hold mostly large cap stocks. And DVY holds mostly financial and utility stocks. Adding a REIT fund Adding a REIT (Real Estate Investment Trust) fund is a good next step to further diversify the retirement portfolio. RWR is a REIT ETF that yields around 3.7%. Click HERE. This portfolio will also satisfy the 4% annual withdrawal by generating cash from interest and dividends. The stock funds should grow modestly over the years. And as the portfolio grows, this will hopefully allow for larger withdrawals to maintain purchasing power.
Conclusion Academic studies using historical data have shown that 4% can be withdrawn from a balanced portfolio (and adjusted for inflation over 30-year periods) with a high degree of success. Bob Brinker recommends a simple 50/50 stock/bond portfolio using the Total Stock Market or the S&P 500 index and a Ginnie Mae fund. This should generate 3.3% cash from interest and dividends. The remaining withdrawal can be taken by selling appreciated shares from the stock fund. This assumes that Brinker has called for a continuation of the bull market. However, when Brinker calls for a bear market, it is unclear what he would recommend to generate sufficient cash flow. Instead of placing the sale of stocks into a money market account as Brinker recommended in early 2000, a retiree could place the proceeds into Ginnie Maes. And then from the Ginnie Mae interest, the retiree would be able to withdraw her 4%. However, there would be some fluctuation to principal. To avoid timing moves, a retiree can substitute the exchange traded fund DVY for the Total Stock Market or the S&P 500 index. This modified retirement portfolio should be able to generate 4% cash without the need to switch between stocks and bonds. A stock portfolio based mostly on large stocks (as in the case of the Total Stock Market or the S&P 500) or mostly on financial and utility stocks (as in the case of DVY) may benefit from the addition of different stock funds. A REIT fund (like RWR) can provide both added diversification and a high yield. Other candidates to diversify a retirement portfolio may include an international dividend fund like PID and a small-value fund like DSV.
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| Note 1 | You can find out more about David Korn's newsletter from the email link at his website Begin Investing.com
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| Note 2 | The following articles are historical studies that have examined “safe” withdrawal rates.
Retirement Savings: Choosing a Withdrawal Rate That Is Sustainable The Retirement Calculator from Hell Determining Withdrawal Rates Using Historical Data Asset Allocation for a Lifetime (pdf)
Conserving Client Portfolios During Retirement (pdf)
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| Note 3 | The 2000-2002 bear market could be instructive. As short-term rates declined, bond fund NAVs rose. This chart shows the NAV change in percentage-terms for the Vanguard Ginnie Mae fund VFIIX.
Source: BigCharts.com |
| Note 4 | From time to time, David Korn posts his current thinking (and that of his guest contributors) regarding Bob Brinker's Timing Model at Suite101.com. Click HERE to read an excerpt from David's September 5, 2006 newsletter.
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| Note 5 | This table shows total returns from different stock funds:
And this chart shows the growth of $10,000 for Large cap stocks (VFINX) and the portfolio of combining the six different funds:
In addition, Paul Merriman and Bill Schultheis have written about the benefits of widely diversified portfolios at their websites.
The following articles are historical studies that have examined “safe” withdrawal rates using widely diversified portfolios. Portfolio Management for Retirees: Is the 'Safe' Initial Withdrawal Rate Too Safe? Decision Rules and Maximum Initial Withdrawal Rates
When Your Portfolio Starts Paying You
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