Author Topic: Strategy for cashing in stock or bund funds for retirement draws  (Read 6537 times)

smiller257

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Strategy for cashing in stock or bund funds for retirement draws
« on: December 02, 2014, 07:13:46 AM »
I am 52 years old, retired at 50 when we sold our software company. We've been using a Financial Planner for many years and this year I have decided to take responsibility for managing our own fianances, it will save us about $500 per month.

Our Financial Planner has us 80% in stock mutual funds and 20% in bond funds. He also set us up Cash Flow Reserve fund that keeps about 1 year of draws that is cash and a bond fund. The reasoning behind this is that if the stock market is down, we would not want to sell securities in a down market. So we replenish the Cash Flow Reserve fund when the market is good.

Most of my investments are in taxable accounts, only a little in Roth IRAs.

2 questions:

1. Do you think the Cash Flow Reserve fund strategy is good? if not, what is a better strategy?

2. When my Cash Flow Reserve Fund gets low, what strategy should I use to refresh it? should I dump the loser mutual funds or withdraw from the best performing mutual funds?

This is my first post to MMM, I just learned about this website and love it!

Steve

wwweb

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #1 on: December 02, 2014, 07:26:50 AM »
I tend to think that cash flow reserve funds like you are describing are a fancy version of market timing and aren't likely to provide much benefit.  They also add considerable stress to managing your investments (deciding if the market is "good") and give you a chance to make costly mistakes.

Keeping one year of expenses in cash and replenishing the cash every 6 months (regardless of market conditions) is a good plan which doesn't require much work.  Generally, you should sell to maintain your desired asset allocation.

Let's say you start with 20% bonds 80% stocks...

If after 6 months you are 25% bonds 75% stocks, you should sell bonds to replenish your cash
If after 6 months you are 10% bonds 90% stocks, you should sell stocks to replenish your cash
If after 6 months you are 20% bonds 80% stocks, you should sell both stocks and bonds to replenish your cash

This method guarantees you are "selling high" and keeps your desired level of risk.  Following a strategy like this is dead simple which makes it hard to screw up - avoiding costly screw ups is key when you're retired.

As always, investment advice on the internet is often worth what you pay for it.  You should chose a strategy that you've comfortable with and matches your life goals.

smiller257

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #2 on: December 02, 2014, 07:32:04 AM »
Thanks wwweb! When selling either the stock or bond funds, I assume I would chose to sell ones who have performed best or should I sell the ones that may be losing money (to stop the losses)?

Malaysia41

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #3 on: December 02, 2014, 07:40:06 AM »
I have a question for you first - what are the fees associated with each of these mutual funds, including the cash reserve fund? 

In answer to your question (and again, FWIW I'm some random internet forum lurker):

1.  If the fees are low on this cash reserve fund it may be fine.  But if the returns are lousy, consider just being in cash or a money market account.  We recently FIRED and we plan to always have at least 6 months living expenses in cash. Right now we're around 2 years cash.

2. Personally, I prefer owning dividend yielding stocks and div yielding ETFs to mutual funds.  For a few reasons.
 a) no taxes: If you keep your ordinary income within the 15% tax bracket, you pay no taxes on 'qualified' dividends.  (make sure the high yield ETF does not hold bonds or REITs however - as those are not 'qualified' sources of income).
 b)  You can turn the spigot on or off by turning automatic dividend re-investment off or on.  This means no forced sales for cash and deciding between good/bad performers for the purpose of raising cash.
 c) No/low fees

Here's an article I wrote - full disclosure - it's a rev share site where I'll get paid a penny (maybe) if you visit it. And perhaps a penny more if you're attracted to the click-bait ads :). 

In my experience, most mutual funds have high fees that in the end lower your returns.  So I'd really be interested in seeing that list of fees.
« Last Edit: December 02, 2014, 07:43:23 AM by Malaysia41 »

Catbert

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #4 on: December 02, 2014, 03:51:50 PM »
I think the Cash Flow Reserve Fund is a good idea.  As to how to replenish it, first really understand your tax situation and how various sells will affect it.  For example, if you're in the 15% bracket you can harvest capital gains to fill up the 15% bracket at 0%.  Once you're above that level its 15%.  Also be sure you understand how your bonds/bond mutual funds work.

I can tell you a bit of what I do...

I ladder zero coupon muni bonds with one maturing each year.  This worked better a few years ago when interest rates were higher.  Interest rates on zero coupon bonds are a bit higher than regular bonds.

I have all  dividends and capital gains internal to mutual funds "paid out" rather than reinvested.  That makes it easier/more automatic to partly re-fill your cash flow reserve fund or re-balance without incurring additional taxes.

If you have stocks that have actually lost money then try harvesting the capital loss to offset capital gains.

To make charitable donations I donate appreciated stock - get the charitable donation but don't have to pay the cap gains.  Fidelity has a Charitable Gift trust that facilitates this.   I'm sure other brokerage houses have something similar.


wwweb

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #5 on: December 02, 2014, 06:30:58 PM »
Thanks wwweb! When selling either the stock or bond funds, I assume I would chose to sell ones who have performed best or should I sell the ones that may be losing money (to stop the losses)?

You're in a tricky situation.  Every fund in my portfolio is there for a reason and has an allocation. e.g.

Fund A (stock) 5%
Fund B (stock) 5%
Fund C (stock) 30%
Fund D (stock) 30%
Fund E (stock) 20%
Fund F (bond) 10%

Each fund was carefully considered over a period of months before being added to the portfolio.  I have a reason for holding each fund in the desired proportions.  If I were retired and cashing out my portfolio, I would use the procedure I described in my earlier post on a fund-by-fund basis.

In your case, your financial planner may not have selected funds for the long haul.  It is possible that you own some wildly inappropriate funds for your life situation.  So, I am hesitant to recommend keeping your funds in proportion.  Without knowing you and your goals well, I would also be unable to tell you which funds are appropriate

Instead, I'll recommend reading A Random Walk Down Wall Street by Burton G. Malkiel (MMM recommends it as well) or anything by William Bernstein.  The advice in those books should give you a good idea how to think about investing.

Good Luck!

GuitarJim

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #6 on: December 02, 2014, 07:10:17 PM »
How have I been missing out on this site all these years?  I feel like I finally met like-minded people.

Anyway, I am almost in the same situation as the OP.  I'm currently 51 and planning to retire next year.  I'm also stressing over what I need to do differently and how to manage cash flow.  As suggested, I am currently leaning toward focusing on dividend yielding stocks and ETFs as a significant component of our income stream.  The remainder, I will manage as much from a tax management point of view as a portfolio management point of view.   

Malaysia41

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #7 on: December 02, 2014, 07:18:51 PM »
How have I been missing out on this site all these years?  I feel like I finally met like-minded people.

Anyway, I am almost in the same situation as the OP.  I'm currently 51 and planning to retire next year.  I'm also stressing over what I need to do differently and how to manage cash flow.  As suggested, I am currently leaning toward focusing on dividend yielding stocks and ETFs as a significant component of our income stream.  The remainder, I will manage as much from a tax management point of view as a portfolio management point of view.

Welcome!  I felt similarly when I discovered the forum.  It was like I'd finally met a group of people waving the same financial freak flag!  I get to chat about $ here and stop coming off like scrooge to family.  Win win!

Dodge

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #8 on: December 02, 2014, 10:36:46 PM »
1. In general, I'd say if you need a Cash Flow Reserve fund, your asset allocation is too heavily weighted towards stocks. It would be much more efficient to withdraw from the portfolio monthly, like a paycheck. This keeps more of the money invested, which will have better returns than keeping it in cash.

Of course, do what you're comfortable with. As wwweb said, the most important thing is to avoid big screw ups. I wouldn't consider keeping a year's worth of expenses in cash a big screw up, as long as you properly replenish it. Honestly, the whole "Cash Flow Reserve" idea just sounds like something a financial advisor pushes to help justify his/her fee. It may feel good, but historically there is no basis for it.

2. Keep the asset allocation the same when making withdrawals. This should help:

http://optimalrebalancing.tk

3.  Stay away from dividend funds. Seriously. I won't sidetrack too much, since you didn't ask about it. Here's a Vanguard study showing how total return trumps dividend investing every time:

https://personal.vanguard.com/pdf/s557.pdf

Bad idea. This is big screw up territory.

4.  I know this might be hard, since the tax ramifications of switching now might be high, but since you just sold the software company, I'm holding out hope that capital gains haven't had time to ramp up yet. I'm afraid you might be in some ridiculous funds, with ridiculous fees, which will definitely be a factor when deciding which funds to sell first. You don't have to share how much money you have in each fund if you aren't comfortable (though it would help the calculation), but can you share which funds you're in? That would really help our recommendations.

Malaysia41

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #9 on: December 02, 2014, 11:49:03 PM »
The vanguard PDF is a good paper.

(my slightly defensive clarification):

By recommend div yielding stocks, my thinking is in line with what the paper calls 'total return' approach - dividend payouts are part of a pay-out strategy.  I also agree that you should pick div yielding stocks that have growth potential (sub 2.5% is what the paper says provide a better return.)  Looking at my div yield stocks, most are between 1.0% and 2.7%, and they are part of a portfolio that includes potentially high returning stocks that pay 0 in dividends too.

In other words, the div paying stocks you choose should look more like stocks than like bonds from a risk and return perspective.  I couldn't agree more.  I do have a tiny amount of very high yield stock but I consider them to be more like bond funds.

And I have zero transaction costs every month as the dividends pay out automatically and fee-free. 

As for taxes: Using div paying stocks makes the most sense if you're able to keep your ordinary income below the 25% tax bracket.  Otherwise, as the authors point out, that 15% is applied to the entire dividend vs. only the capital gains portion of the divestment.   Next year we intend to have low ordinary income so all qualified dividends should be federal-tax free.  As will be LTCGs.

This passage seems relevant for OP:
"If ... the cash flows from taxable registrations appear to be less than the required annual spending amount, the gap can be met by selling assets from the taxable portfolio.  The investor should choose whichever asset would produce the lowest taxable gain, or would even realize a loss."  ...  then they go on to say you should rebalance in your tax advantaged account to offset the skewing of asset allocation in your taxed accounts. Makes sense to me.


I think the first step, though, is taking a look at those fees on the mutual funds you own.
« Last Edit: December 02, 2014, 11:53:57 PM by Malaysia41 »

Dodge

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #10 on: December 03, 2014, 12:19:46 AM »
The vanguard PDF is a good paper.

(my slightly defensive clarification):

By recommend div yielding stocks, my thinking is in line with what the paper calls 'total return' approach - dividend payouts are part of a pay-out strategy.  I also agree that you should pick div yielding stocks that have growth potential (sub 2.5% is what the paper says provide a better return.)  Looking at my div yield stocks, most are between 1.0% and 2.7%, and they are part of a portfolio that includes potentially high returning stocks that pay 0 in dividends too.

In other words, the div paying stocks you choose should look more like stocks than like bonds from a risk and return perspective.  I couldn't agree more.  I do have a tiny amount of very high yield stock but I consider them to be more like bond funds.

And I have zero transaction costs every month as the dividends pay out automatically and fee-free. 

As for taxes: Using div paying stocks makes the most sense if you're able to keep your ordinary income below the 25% tax bracket.  Otherwise, as the authors point out, that 15% is applied to the entire dividend vs. only the capital gains portion of the divestment.   Next year we intend to have low ordinary income so all qualified dividends should be federal-tax free.  As will be LTCGs.

This passage seems relevant for OP:
"If ... the cash flows from taxable registrations appear to be less than the required annual spending amount, the gap can be met by selling assets from the taxable portfolio.  The investor should choose whichever asset would produce the lowest taxable gain, or would even realize a loss."  ...  then they go on to say you should rebalance in your tax advantaged account to offset the skewing of asset allocation in your taxed accounts. Makes sense to me.


I think the first step, though, is taking a look at those fees on the mutual funds you own.

Putting any amount of your money in a dividend funds, or a dividend stock, is inherently more risky than putting it in a total stock index fund, or a total bond index fund.  It will be less diversified (higher risk) and lower returning at best, and filled with hand-selected dividend stocks (active trading) at worst.  If you're talking about a fund, it will also be more expensive.  If you're using dividend stocks in lieu of bonds, specifically because you can't handle the volatility of a 100% stock portfolio, you're headed towards disaster.

Again, this is big screw up territory.

I don't know what the rest of your portfolio looks like Malaysia41, I'm not referring to you specifically, just speaking in generalities.  Back when you couldn't sell a fund without paying a large fee, dividend stocks were essential.  This is no longer the case.  When a stock pays you a dividend it's mathematically the same as you selling a portion of your holding.  Think of it as a forced sale.  I recommend keeping it simple and sticking with the total stock and total bond index funds.

Mr. Frugalwoods

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #11 on: December 03, 2014, 05:48:04 AM »
There's a good Kitces writeup of the current thinking about cash reserves:

https://www.kitces.com/blog/research-reveals-cash-reserve-strategies-dont-work-unless-youre-a-good-market-timer/

In short, they don't really work.  But if it makes you sleep better at night knowing you have a year's worth in the bank it probably won't hurt you that much.

Malaysia41

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #12 on: December 03, 2014, 06:57:23 AM »
TBH my biggest holdings are dividend paying index funds - the biggest one is VTI - Specifically for the diversification.    I should have stated that - I'm not talking only about specific company stocks, when I say dividend paying I mean ETFs too.  I do hold specific companies too because I like picking stocks.  But, it's a diversified mix and tallied up - a small portion of our portfolio. 

Yes I'm all for diversification through index ETFs / index funds.  I don't advise going out and buying, say, GE and GE only because it pays a dividend.  You still need to pick a diversified portfolio according to your desired asset allocation.  This can (and IMO should) include index ETFs.   

* actually my biggest holding is company stock which I'm in process of divesting ourselves of but don't want a big tax hit this year, so it's still too high.

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #13 on: December 03, 2014, 08:27:20 AM »
How have I been missing out on this site all these years?  I feel like I finally met like-minded people.

Maybe because it's only been a few years the site has been in existence?  I think MMM started the blog in 2011, not sure when the forum started.

I concur with other posts here that this boils down to market timing, which for me personally is too much pressure/hassle.  I like the idea of regularly scheduled moves to cash, with the source of the funds coming from whichever area re-balances your portfolio.

Malaysia41

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #14 on: December 03, 2014, 08:54:18 AM »
There's a good Kitces writeup of the current thinking about cash reserves:

https://www.kitces.com/blog/research-reveals-cash-reserve-strategies-dont-work-unless-youre-a-good-market-timer/

In short, they don't really work.  But if it makes you sleep better at night knowing you have a year's worth in the bank it probably won't hurt you that much.

I've always figured 6 months cash reserves was the right number.  Maybe we should go to 3 months.  It would be interesting to see the results swept over months of reserves rather than years. 

As for periodic re-balancing: my problem is that I haven't truly decided on my optimal asset allocation.  So I'm somewhat just winging it.  I've got eggs in lots of baskets.  Whether I've sized those baskets optimally, well, probably not.   Financial circumspection commencing.

smiller257

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #15 on: December 03, 2014, 12:28:57 PM »
Thanks to everyone that responded, this has been really helpful. It has also forced me to research the pros and cons of having a cash flow reserve fund in general. I will probably dial the cash flow account down to a 3 to 6 month reserve and refresh it with dividend payments (I do have some) and stock/bond funds that re-balance my asset mix for extra cash needed. I will also keep capital gains in mind when deciding which funds to sell so that I am not overpaying in taxes. All of my funds are no load funds.

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #16 on: February 25, 2015, 08:51:47 AM »
My thinking is that a cash reserve is only a significant drag on your FIRE investments if one or both of these are true:

1. you FIRE with insufficient funds for your planned withdrawal rate

2. you feel leaving a large inheritance is vital to your heirs

Otherwise it's pretty simple to withdraw some extra $$ in years with returns well above your planned withdrawal rate and put the excess funds into a safe investment that keeps pace with inflation and is liquid enough for your needs, but isn't linked to market performance.

Your investments will still grow and you'll have the flexibility to live for a reasonable amount of time from these funds if the market crashes without having to sell investments when they have tanked to live off of.

The main concern with market timing issues is that you don't know what the market will do next. True. But, you do know if the market is performing above or below your planned withdrawal rate and if you use that as you mechanism to decide if you should add or take money out of your emergency funds you don't have to second guess yourself.

Your only risk is that you might have made an even larger fortune by leaving more emergency funds in the market. Having the peace of mind of 1-3yrs of living expenses seems well worth it to me.

-- Vik

Eric

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Re: Strategy for cashing in stock or bund funds for retirement draws
« Reply #17 on: February 25, 2015, 01:15:58 PM »
There's a good Kitces writeup of the current thinking about cash reserves:

https://www.kitces.com/blog/research-reveals-cash-reserve-strategies-dont-work-unless-youre-a-good-market-timer/

In short, they don't really work.  But if it makes you sleep better at night knowing you have a year's worth in the bank it probably won't hurt you that much.

That's a really good article.  Thanks for posting.  I need to read more of Kitces' stuff.  He's pretty sharp.  I'm going to start with the one linked in the article above about "how more dynamic asset allocation strategies can directly increase sustainable withdrawals."


Thanks to everyone that responded, this has been really helpful. It has also forced me to research the pros and cons of having a cash flow reserve fund in general. I will probably dial the cash flow account down to a 3 to 6 month reserve and refresh it with dividend payments (I do have some) and stock/bond funds that re-balance my asset mix for extra cash needed. I will also keep capital gains in mind when deciding which funds to sell so that I am not overpaying in taxes. All of my funds are no load funds.

No load funds are better than loaded funds for sure, but it's also important to look at the Expense Ratio of each fund.  If you're paying between 1-2% per year, that's going to be a huge drag on performance compared to say, a Vanguard Index Fund like VTSAX with an Expense Ratio of .05%. 

To give you an example, lets assume $500K invested.  Holding constant the rate of return (7%), over 20 years, the difference between $500K invested in a fund with a 1.5% ER and a .05% ER are fees paid of $458K.  Wow!

 

Wow, a phone plan for fifteen bucks!