Q. My wife and I recently retired (she is in her late 50s and I am 63). We do not have pensions, so we are totally dependant on our investments and a rental property. Our retirement income strategy is as follows: when markets are up, we draw from our equities, and when they are significantly down, we rely on maturing GICs so we don’t have to sell equities at a loss. But during the in-between times, when markets are not up or down sharply, it is not obvious what to do. Maybe there is no perfect answer, but is there an indicator to help us decide?
– Bob K.
A. It sounds like you’ve got the basics exactly right, Bob. You’ve recognized that generating cash flow in retirement and rebalancing the portfolio can go hand in hand. That is, if your portfolio is overweight in equities because markets have been strong, you can sell some of your equity holdings to get back to your target asset allocation and then use the proceeds for spending money. And when equity markets have been weak and you’re overweight in fixed income, you can spend the proceeds of a maturing GIC (or sell some bond holdings) to accomplish the same thing.
But, as you’ve found, sometimes markets are relatively flat, and when it’s time to make the next withdrawal from your portfolio nothing is too far out of whack. Then what do you do?
One fairly obvious answer is to simply take a little from both sides of the portfolio: that is, sell some equities and some fixed income to generate the cash you need. For this to work, however, you’ll need to keep some money in bonds, which are fully liquid (that is, they can be sold at any time). If all of your fixed income is in GICs, you won’t be able to sell: you’ll have to wait until a GIC matures before you have access to the cash. That’s why we recommend using a mix of both GICs and bond ETFs in your portfolio to provide more flexibility.
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But there’s another way to manage your cash flow, Bob. An example will help explain. Let’s say you have $600,000 in your portfolio and your target asset allocation is 50% equities and 50% fixed income. And let’s also assume you need $20,000 in annual income from the portfolio to supplement your government benefits and rental income. You could set up the portfolio like this:
- $20,000 in a high-interest savings account
- $100,000 in a ladder of five GICs: $20,000 in each maturity from one to five years
- $180,000 in a bond ETF
- $300,000 in equity ETFs
If we assume the $20,000 in cash is part of your fixed income allocation, then your portfolio is now right on target at 50/50. You can now use that $20,000 to fund the next year’s worth of expenses. In a year, one of the GICs will mature for $20,000 and you can use the proceeds to top up the now-depleted savings account, providing you with another year’s worth of cash.
Once that’s looked after, you can sell $20,000 worth of equity and/or bond ETFs and use those proceeds to buy a new five-year GIC to replenish your ladder. The amount of equities and bonds you’ll sell will depend on how markets performed over the previous year: the idea is to use this opportunity to sell the winners and top up the losers so you can rebalance your portfolio at the same time. (In a very good year for equities, you might need to sell more than $20,000 and buy some bonds as well as a new GIC to get you back to your 50/50 target.)
The beauty of this strategy is that it allows you to lock in six years’ worth of cash flow (the $20,000 in cash and the $100,000 in GICs), so you don’t ever have to worry about short-term volatility in the markets. Retirees find this very comforting because it makes their cash flow smooth and predictable.
For a more detailed description of this strategy, see the following article:
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