Over the 18 years I’ve spent in this field, I’ve had plenty of time and opportunity to think about the best ways to manage investment portfolios.
I’ve also answered a lot of questions in those 18 years. One of the most difficult questions I have to answer is also one of the most common. “Dave, how much money can we safely spend once we retire?” As you may or may not know, the vast majority of Americans have no idea how to answer that question. I’m guessing you probably struggle with that question yourself.
Here is the problem: You don’t want to just sit on your money, living in fear, only to one day die with more money than ever but with little to no fulfillment or joy from your retired years. That is not an acceptable solution.
So, what other options are there?
You could take your nest egg, divide it by the number of years you think you are going to live and dole out that money throughout your retired years. The problem with this line of thinking is obvious — you don’t know how long you will live. While you deserve to enjoy the fruits of your labor now, you don’t want to do it at the expense of your long-term financial health.
We don’t want to die rich in cash but poor in fun, and we don’t want to run out of money. What is the solution?
This is a tough question, isn’t in? Luckily, I have an answer. While no answer is perfect, this is the best technique I can muster: You spend the money that the money is making.
Let me say that again: If your CD is making 3%, spend the 3%. If your portfolio of stocks and bonds is returning 5% on average, spend that. If you have all your money buried in the backyard … I’m afraid I can’t help you there.
This is completely logical, right? If you only spend the earnings, you will never run out of money. You will always have at least the principal. It is the perfect balance between spending too much and spending too little.
“What if I have to go to a nursing home?” You still have the principal. You still have the original amount.
“What if I live to 105?” You still have the principal. You still have the original amount.
Once you agree that you can safely spend the money your money is making, the next question is: Where do I put my money to maximize the “money that the money is making?”
This is where nearly two decades of research, study and experience come in handy. The answer: A diversified and balanced portfolio of stocks and bonds. Period. While some people are so ultra-conservative that they are happy with the 2% return on their money market, I think it is the wrong answer. I always recommend that you utilize the stocks and bonds strategy, and then withdraw 5% per year. The growth of the portfolio will fill it back up each year and then you do it again.
“But Dave, my portfolio doesn’t have the same return every year. Do I spend more money the years that I make a lot of money on my investments, and no money of the years they go down?”No, you take out 5% per year, regardless of the year’s return.
Hundreds of years of data point to the same fact: If your portfolio doesn’t average 5%, it is the first time in modern economic history where it hasn’t.
Remember, if the stock market is down on the year, bonds are almost certainly up. Bad year in the markets? Take your 5% from the bond part of the portfolio that year. Stock market has a great year? Pull the money from the stock part of the portfolio that year. This way you can literally “take the money that the money is making.” If stocks are down, you take the profits from bonds. If stocks are up, you take the profits from stocks.
“But Dave, sometimes I see my portfolio values going down AND I’m taking out my 5%.” I know it feels strange, but the strategy holds true. If you want a more thorough investment discussion, I’ve written dozens of articles on the subject. Just go to www.KennonFinancial.com.
So spend that money that the money is making without fear. Be empowered to know that you are spending the perfect balance between too little and too much.