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Quickly liquidate assets
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favorable investment markets.
PART 5 of 7 Series:

The Process of Managing Retirement Income

One of the challenges that confronts retirees and their advisors is how to prevent having to sell their hard earned retirement assets at the wrong time. 

We have all heard the age old investment adage "Buy Low and Sell High," which tells us to buy assets when they are out of favor but to time the disposition of the assets when the markets are in your favor.

This timing is even more important for retirees since they are liquidating assets to support expenses and not reinvesting. Therefore, one goal for each retiree and their advisor is how to prevent being in a position of having to sell their retirement assets for less than their potential worth.

When structuring a retirement investment portfolio, there are two tenets that can be followed which may help achieve this goal.
  • The first is to invest the retirement savings in a well-diversified portfolio that includes cash, fixed income, and equity investments. Preferably, the equity investment allocation should focus on providing a high and growing dividend income stream. 
  • The second is to implement a Cash Flow Reserve (CFR) Ladder that can provide monthly income during retirement and can allow the retiree and their advisor the ability to dictate when to sell assets into the market. 
Historically, fixed income and equity assets have had a tendency to be favorably priced at different times in the market, giving the retiree the ability to time the disposition of the retirement assets when it may be most optimal. Using a ladder structure that includes a cash flow reserve for near-term expenses, and both fixed income and equity assets for intermediate and longer-term expenses, is one structure that may help achieve this goal.

The consequences of not being diversified and then forced to sell into a bear market can be significant.
Structuring a Cash Flow Reserve Ladder

A Cash Flow Reserve Ladder is comprised of three "rungs" that strive to align the least volatile assets to meet the retiree's near-term expenses while giving equity assets the opportunity to grow. This potential growth of the equity investments is intended to offset the eroding effects of inflation on the retirement savings.

Checking Account

On the first of each month, the retiree writes a check from the cash flow reserve and deposits it into the checking account to pay for expenses. This provides a monthly cash flow, which from a behavioral finance perspective is very healthy and allows the retiree to budget for monthly spending accordingly.

Cash Flow Reserve
The cash flow reserve is comprised of two years' worth of spending needs in short-term assets such as a money market account and possibly a limited-term bond fund. The retiree draws a check from the cash flow reserve to deposit into the checking account at the beginning of each month. The relative liquidity of this rung can provide the retiree with the ability to cover two years of spending. Having two years' worth of disposable assets can be key to helping alleviate ill-timed selling into a bear market. At the end of each year, or as the market dictates, the advisor will sell either fixed income or equities from the investment portfolio to refill the cash flow reserve to cover the next two years of expenses.

Investment Portfolio

Fixed income investments have historically performed better when equities are out of favor; therefore, having a balanced portfolio of fixed income and equity investments can help alleviate selling retirement assets at a less opportune time in order to fund retirement spending. In this rung of the ladder, there will typically be enough fixed income investments to pay for an additional four to five years of spending. Also included in this rung is an allocation to equity investments, which have historically been more volatile than fixed income assets but also provide the potential for higher returns over time. While the equity investments may provide the necessary growth to help offset the eroding effects of inflation in retirement, retirees also need to have the flexibility to sell assets when the markets are attractively valuing those investments. The assets from this rung are used to replenish the funds in the cash flow reserve as needed. Again, the goal is to have the flexibility to sell either the equity or the fixed income assets at an opportune time.

Asset Allocation Alternatives
Now that we know the basic structure and operation of a Cash Flow Reserve Ladder, let's discuss just a few of the many ideas for how the retirement assets can be allocated to each rung. The most appropriate investments will vary depending on an individual's needs and investment objectives and should be discussed with a financial advisor.

Retirement Investment Portfolio

The Cash Flow Reserve Ladder approach allows the retiree and advisor time to liquidate assets into potentially more favorable markets.

Using a high and growing dividend-paying stock fund in this rung may provide the double benefits of a growing dividend stream to contribute to the current income needs of the retiree and the potential growth that is historically associated with equity investments.

Utilizing the structure of a Cash Flow Reserve Ladder with a well-diversified retirement portfolio during the distribution phase of retirement can provide retirees with the necessary foundation and discipline to alleviate selling their retirement assets into a bear market. The cash flow reserve has the ability to provide two years of liquidity, thus allowing expenses to be met readily. The investment portfolio has a mix of intermediate-term fixed income and equities focusing on a high and growing dividend income stream that may be liquidated during opportune times in the market to refill the cash flow reserve. Hopefully, this type of structure can help the retiree stay on plan and meet expenses.

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Following this strategy does not assure or guarantee sustainability of a retirement portfolio, better performance, or protect against investment losses.

Investments in a money market are not FDIC insured, nor are they deposits of or guaranteed by a bank or any other entity. Although a money market fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in a money market fund.

Rebalancing - refilling the money market fund with an allocation from the equity account at the beginning of each year, except in 2009, when the decision was made not to replenish and ride through the turbulent equity and fixed income market. No further rebalancing was necessary.

Monthly Cash Flow - monthly check withdrawn from Cash Flow Reserve and assumed placed into checking account at the beginning of each month.

The Consumer Price Index (CPI) measures prices of a fixed basket of goods bought by a typical consumer, including food, transportation, shelter, utilities, clothing, medical care, entertainment and other items. The CPI, published by the Bureau of Labor Statistics in the Department of Labor, is based at 100 in 1982 and is released monthly. It is widely used as a cost-of-living benchmark to adjust Social Security payments and other payment schedules, union contracts and tax brackets. Also known as the cost-of-living index.

The S&P 500 Index is an unmanaged broad measure of the U.S. stock market.