While many of us like to cover our retirement spending with portfolio income, that can be constricting and might not allow us to take full advantage of a robust bull market.
Of course, the US markets have had a wonderful ride for the last decade coming out of the financial crisis. Courtesy of PortfolioVisualizer.com, here is the US market from January 2009, represented by the iShares Core S&P 500 ETF (IVV) that tracks the cap-weighted S&P 500.
We see an incredible return of over 13.5% annually, and with a maximum drawdown (with dividend reinvestment) of just 17.83% for the period. These have been wonderful years for the accumulators and those in retirement. Those who have retired during the last 10 years have mostly landed on a very fortunate retirement start date. That said, we should remember that the Retirement Risk Zone is typically described as 5 years before retirement and the first 5 years of retirement. Read more here: "You should protect your retirement portfolio assets long before your actual retirement date".
It's crucial that we protect our assets within that period, and that includes de-risking, or "risking down", 5 to several years before the retirement portfolio funds are required. Job 1 is getting the portfolio battle ready. Remember, an unfortunate start date and an ill-prepared retirement portfolio can permanently impair the portfolio and retirement.
That said, if the market comes along and says here's an early retirement gift, be prepared to accept that gift. That gift might be a year of 15%, 20% or even 25% stock returns. You might be able to sell shares to create additional income and not put your long-term retirement prospects in jeopardy.
While 2009 included the tail end of the bear market of the financial crisis, the year ended more than well and delivered returns over 26%. 2010 added on to the retirement festivities with returns over 15%. Only 2011, 2015 and 2018 got a little stingy on the returns front. And that said, it's likely that a retiree taking note of the retirement risk zone would enter the year with a strong cash position. Many will enter the first year of retirement with the full spending requirements covered in cash. A retiree might have used the wonderful market gains of 2009 and 2010 to fill that cash bucket. They would then be able to accept the additional gift that was offered in 2012 and 2013 and 2014, had they landed on the 2011 retirement start date.
As was noted in the article "Retirement Income For Life: Getting More Without Saving More", we might be prepared to have a dynamic spending plan in retirement that can include making hay when the sun shines. On the flip side, that can include tempering spending plans (perhaps modestly), should a retiree run into an unfortunate and extended stock market rout.
Of course, to access that additional value that the stock market prices have offered, you would have to sell some shares. If you're locked into a "living off of the income, never sell a share" mode, you won't be able to access that value and added lifestyle boost. While I certainly recognize the value and comfort of portfolio income, it can be limiting in many ways if one has concrete rules about not selling shares. Consider being prepared to harvest some shares (in modest fashion) and create those homemade dividends.
If share harvesting is practiced with caution and executed within reason, it should not put your portfolio in harm's way. For example, if you had started with a portfolio value of $1,000,000 (for argument's sake) and you harvest the 4% or portfolio value in a year when the markets offered an extraordinary 20% gain, you have a generous amount of room to give yourself a little bonus. Of course, your portfolio is likely not going to be at 100% equities. Even as an aggressive investor, you might be in that 75% equity range with 25% in cash and bonds. For the equity funding component, you'll have $750,000 exposed to that 20% gain if you're in a market fund or matching the returns of the S&P 500.
You might even offer yourself an additional bonus of 2% of portfolio value. You might harvest at $60,000 (6% spend rate). For the year, that $750,000 equity component has delivered an incredible $150,000 of capital appreciation. That's a lot of wiggle room. You'd have additional income, and you'd enter the next year with considerably greater total portfolio value. And if you harvest from the equities only and the bond markets hold up, you'll also enter the next year with more assets in stocks and bonds. A retiree might also rebalance and move additional stock market gains to keep that 75/25 stock-to-bond allocation. Keep any tax consequences in mind, of course.
And we might also consider that income and spending power has more personal value early in retirement when we are young and healthy. Enjoy the monies while we can. Our spending needs typically decline in our later years, after the early 70s, as our health and energy declines. We then become more "homebodies". Now keep in mind that a medical emergency or extended poor health can be a game changer and can create a scenario where generous funds are required later in life. US retirees should do everything possible to ensure that they are covered with proper insurance. Also, look into the gaps in Medicare. You can drive a truck through them.
For those that hold portfolios of individual stocks, they may choose to harvest from one or more of the runaway winners. My readers will know that I made homemade Apple (AAPL) dividends to fund a couple of trips to Prince Edward Island.
From our portfolio of skimmed Dividend Achievers (VIG), tech darlings such as Microsoft (MSFT), Texas Instruments (TXN) plus Abbott Labs (ABT) and Nike (NKE) would be candidates for some share harvesting, if that was required.
From January 2015, here's the performance of Microsoft as Portfolio 1, Texas Instruments as Portfolio 2, and Abbott Labs as Portfolio 3.
Our portfolio of US stocks certainly could have supported a spend rate of 5-6% from 2015. Of course, that would require a combination of dividends and share harvesting. And this has been an extraordinary period of growth.
But spend we should. While many retirees will run into trouble, this article from Michael Kitces links to a study that shows more affluent retirees simply don't spend the assets available. They don't even spend the portfolio income.
Portfolios get into trouble when we spend too much of the total value in too many years. As you know, there is that 4% rule, but that is only a rule of thumb guideline, and those thumbs are made to be broken here and there. But over longer periods, we typically do not have the opportunity to spend at 5%, 6%, or 7% for multiple years. The markets and inflation historically did not allow for such an aggressive level of portfolio harvesting.
Check in with a retirement specialist planner when in doubt. And if you need the funds to be more sustainable over a longer period, don't move your portfolio into an area where you need to harvest at 5% or more to meet your spending needs. There is a massive distinction between taking the gifts of the market in good years and trying to push a retirement portfolio too hard.
Author's note: Thanks for reading. Please always know and invest within your risk tolerance level. Always know all tax implications and consequences. If you liked this article, please hit that "Like" button. Hit "Follow" to receive notices of future articles.
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Disclosure: I am/we are long BNS, TD, RY, AAPL, BCE, TU, ENB, TRP, CVS, WBA, MSFT, MMM, CL, JNJ, QCOM, MDT, BRK.B, ABT, BLK, WMT, UTX, LOW, NKE, TXN, PEP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.