Investors at or near retirement and investors seriously planning for retirement should look beyond portfolio yield and consider the concept of a managed payout. Managed payout offers more favorable income levels for retirees without increasing investment risk. More and more mutual fund companies are creating managed payout funds but methodologies are murky and fees can be high. Discussed here is an example that allows an investor to implement their own managed payout income strategy with low cost index ETFs. I will post updates when this portfolio is re-balanced, when the asset allocation is reset annually and when the managed payout rate for the year is changed. Investors should note that this portfolio and the sample payout strategy are not applicable for everyone. Each investor should consider their unique circumstances and risk appetite before investing in the ETFs discussed herein.
The ETF Retiree Portfolio Overview
Below is the asset allocation of the Retiree Portfolio from MarketGlide and one example of an appropriate ETF investment for each asset class. This asset allocation was generated based on the market consensus of the 30 top asset managers – the asset allocation recommended for a retiring 65 year old. An article in the Journal of Indexes located featured this methodology and is available here.
Total equity investments are diversified across seven sub-asset classes and account for 39.9% of the portfolio. Bond investments are diversified across 4 sub-asset classes and account for 42.3% of the portfolio. Cash is 17.8% of the total. The portfolio gets re-balanced quarterly and is updated annually to reflect changes by the 30 top asset managers based on their revised market outlooks and updated asset allocation strategies. You can access this portfolio for free by signing up here.
MarketGlide Retiree Portfolio - Asset Class and ETF Allocations
The Portfolio - Current Yield
The current yield for this portfolio of ETFs based on the past 12 months is 2.32%. This is the yield you can collect without tapping the principal. The principal amount and yield are both subject to market movements, but the principal is likely to grow over a long-term time horizon (example: 35 years, assume age 65 now to age 100). If you are 65 and spend only the current yield for the next 35 years you are likely to have more money in 35 years than you do today. This is not an optimal retirement spend down strategy for most investors.
The Portfolio – Managed Payout
Managed payout assumes a payout rate that includes current yield and a conservative level of principal spend down based on projected portfolio growth over time. The goal is to have $0 when you die (assumed to be 100 here), and to find the annual percentage of portfolio amount you can safely spend that results in a portfolio balance of $0 or more at age 100. Since we are spending principal the goal is to be very conservative so the money has a high probability of lasting the 35 years while paying out a healthy income stream, much higher than the current yield noted above.
Managed Payout Calculation
The goal is to calculate a single number - annual spending as a % of the portfolio value. To determine the annual spending percentage we project thousands of potential future scenarios and apply them to the portfolio for 35 years. The software optimizes an annual spending amount based on the projected portfolio return, time horizon and confidence levels. The results below show the applicable rate for year 1 which is also a good target for future years as well. Note that it is a good idea to re-calculate this percentage every year and expect some adjustments up or down from year to year. Investors can also divide the result by 12 to get a target monthly withdrawal rate. Here is a conservative approach to developing a managed spend down percentage with this ETF portfolio:
Age today: 65
Target Age for $0: 100. (Note this is 20 years beyond current expected life expectancy of men and 17 beyond the life expectancy for women.)
Scenario Confidence Level: Confidence that 85% / 95% of future economic/market scenarios will result in investment performance that generate annual spending levels and result in $0 or higher ending balance at age 100. For more detail on projections see appendix at end of this article.
ETF Portfolio – Application in the Real World
This ETF portfolio and spend down rate is ideal for an investor looking to allocate a portion of his/her portfolio to generate income over a long period of time, and is not concerned about a significant residual end value for the portfolio. An investor at or near retirement could consider this portfolio as a way to provide relatively stable income while still retaining control of principal and passing it to a spouse or heirs in the event of an early death (unlike an annuity). Here is a step by step process:
- Purchase the ETFs to create a portfolio weighted as noted above
- Use 4.39% or 3.93% withdrawal rate to set year 1 withdrawal and allocate that to a money market.
- Divide first year principal withdrawal by 12 and set up monthly withdrawals for year 1.
- Follow me or sign up at MarketGlide.com to get free quarterly rebalancing updates. Execute quarterly re-balancing.
- Follow me or sign up at MarketGlide.com to get annual updates to consensus asset allocation and ETF allocations. Execute any allocation changes.
- Follow me or sign up at MarketGlide.com to get annual updates for managed payout rate changes.
- Repeat starting at Step 2.
Additional Information - Capital Market Assumptions, Projections and Monte Carlo
The ETF portfolio performance is projected using wealth forecasting software used by top financial institutions in the world. The Monte Carlo process projects thousands of future economic scenarios based on historical returns and covariances of asset classes listed in the table above.
Monte Carlo simulation based on normal distributions has come under significant criticism since the crisis of 2008, but it is still the best way to project wealth for a long term time horizon like 35 years. Also, 85% and 95% confidence levels make the projections very conservative.
Performance In a Down Market
As a quick test for performance in a down market I looked at performance in the case I had initiated the portfolio at the beginning of 2008. Even if we started the portfolio in 2008 and watched it get crushed with a drawdown of 24% in 2008, we can still see a positive return three years later. By all measurement 2008 was one of the most extreme worst case scenarios ever applied to the investment markets.
More Information on Asset Allocation Methodology
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.