September 5, 2023 • 20 mins
It’s common knowledge to have a different portfolio allocation before retirement than you actually have in retirement. But how and when do we actually go about making that change?
This episode is based on a listener question: Alan, has a portfolio mix weighted too heavily in stocks. As he shifts into retirement, he is looking to have a new allocation strategy.
James discusses how to shift into a different allocation, when the right time to do that is, and what makes the most sense for Alan’s situation.
Questions Answered:
How do we shift into a new allocation strategy?
When should you begin that process?
Timestamps:
0:00 Intro
3:08 The framework
8:41 Where should you hold assets?
14:14 What’s the timing?
18:14 In summary
19:11 Outro
Create Your Custom Strategy ⬇️
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:00):
We all know it makes sense to have a different
portfolio allocation beforeretirement than you actually
have in retirement, but how andwhen do we actually go about
making that change?
That's the topic for today onReady for Retirement.
This is another episode ofReady for Retirement.
I'm your host, james Cannell,and I'm here to teach you how to
(00:20):
get the most out of life withyour money.
And now on to the episode.
Today's topic is based on alistener question, and this
question comes from Alan.
Alan says this James, I reallylike your podcast.
You always bring a lot of usefulinformation that I can
incorporate into my retirementplan.
I will be retiring in a fewmonths and unfortunately I am
weighted way too heavily instocks and need to add more
(00:42):
fixed income to balance out myportfolio.
It's my fault for not doing itearlier.
We will be getting about twohundred thousand dollars on the
sale of my mother's house verysoon.
We've already maxed out ourIRAs this year, but even if we
didn't, it would only addfifteen thousand dollars to our
portfolio.
We probably need to add anotherfifty thousand to seventy five
thousand dollars to fix income.
The only option I see is to putthat money into a taxable bond
(01:05):
fund.
We're only in the twelvepercent tax bracket, so it
wouldn't be a huge tax hit.
Any other thoughts you may haveas to where to put the bond
fund or at least how to balanceout the portfolio?
Thank you, alan.
Well, thank you for thatquestion, and essentially what
he's asking is I have myportfolio mix, but this
portfolio mix is maybe tooheavily weighted towards stocks,
(01:26):
because I've been growing myportfolio and so I've had a
stock and a growth focus.
But now I'm gonna retire and asI'm retiring, I now need to
make an abrupt shift towards anew allocation, because I'm too
heavily weighted in stocks andon top of that, I have this new
inflow of cash coming in.
How do I think about this?
How do I go from where I amtoday to where I should be with
(01:48):
my portfolio allocation?
And that's exactly what we'regonna talk about today.
Before we jump in, I willhighlight the review of the week
, and this comes from usernameAJ Dubia, and AJ says five stars
.
James discusses topics that arerelevant to aspiring retirees,
along with those of us who havealready taken the plunge.
His communication style andtopics are both informative to
(02:08):
those of us who arecontemplating retirement, but
also engaging for those of uswho are already a little more
informed and always looking tolearn more about retirement
planning.
Keep up the great work.
Five-star review.
Well, aj, thank you very muchfor that.
Thank you to everyone who'sleft reviews.
If you have not already done so, and if you've gotten any value
of this show, would reallyappreciate you taking a moment
to do that.
Also, make sure that you checkus out on YouTube, if you
(02:31):
haven't already.
The YouTube channel name usedto be root financial.
It's now just under my name,james Kanol, so you can find it
there.
Where you can find this episode, which is just the podcast, and
there's also videos we releaseevery single Saturday to make
sure that you are preparing thebest you can for retirement,
ultimately in that effort to getthe most out of life with your
money.
So on to the podcast episodefor today.
(02:54):
So how do we start to make thisshift from where we are to where
we want to go?
Seems like a fairlystraightforward answer of you
should do this five years outand you should do that three
years out, and there's someformula that you should follow,
but unfortunately, that's notnecessarily the case.
Here's actually the frameworkthat I would apply, and I would
start by taking a big step back.
Here's the order of operations.
(03:14):
I would do things in number one.
I would first ask you what isyour target investment
allocation?
Why does this matter?
This matters because so oftenwe jump right into the.
I'm retired, therefore, I needto be more conservative mindset
now.
Sometimes that is the case.
Oftentimes that's the casewhere, when you're retired, your
portfolio allocation should bea little bit more or a lot bit
(03:37):
more Conservative than yourworking year allocations, but
that's not always the case.
What you need to ask yourselfinstead is what role does my
portfolio play in creating theincome I need to create in
retirement?
So, in other words, how doesthis supplement or how does this
play along with my other incomesources, like social security
(03:58):
or pension or rental income orpart-time work or whatever the
case might be?
But what specific needs do Ihave from my portfolio?
Let's look at a super basicexample just to illustrate this.
Let's assume that Alan retiredand he has pension and a social
security benefit that combinedfor $6,000 per month.
But let's also assume that Alansays do you know what?
(04:18):
I only want to spend $5,000 permonth.
Well, in that example, alan'sportfolio or anyone's portfolio
for that matter, could be viewedas extra.
We still want to manage itcorrectly, we still want to make
sure that we're making wisedecisions with it, but he's not
dependent upon it to generatecurrent income so that he can
survive.
Now I don't know Alan's livingexpenses, I don't know how
(04:39):
there's other income sources.
It wasn't part of the question,but just using that as an
example, that's a very basicexample of when you wouldn't
necessarily need your portfolioto get more conservative in
retirement.
Here's another example.
Let's assume that you have amillion dollar portfolio and you
need $20,000 per year from itbecause that 20,000 will
supplement your social security,your pension or other income
(05:02):
sources.
Well, you look at that and whatI would look at first is what
cash income is that portfoliodelivering?
So say, hypothetically, it'sentirely in stocks, it's
diversified, it's well-spreadout, but the whole million
dollars is stocks.
Well, my guess is thatportfolio would be generating at
least $20,000 per year just incash dividends.
(05:23):
So, even though in this exampleyou actually do need some of
your portfolio, there's stillcash dividends being paid, to
the point that you wouldn't haveto sell any of your stock
investments to create income,even if there was a downturn in
retirement because, again, thewhole reason we don't have the
entirety of our portfolio instocks and retirement is there
(05:43):
will be downturns.
They happen very regularly.
Now they're temporary, but weneed to be in a position where
we're not having to sell ourstock investments to free up
cash for distribution for livingexpense needs when those
downturns are happening.
Now let's look at a finalexample.
Let's assume that you have thatsame million dollar portfolio,
but this time you need $50,000per year from it.
(06:04):
Let's assume the same portfoliois still delivering $50,000 per
year in dividends.
A quick side note, real quick,that's important to note with
this conversation as we'reincorporating dividends is
dividends that companies paytypically remain very consistent
, even if that company stockprice has fallen 20, 30, 40%.
Now there are exceptions tothis and we need to prepare for
(06:25):
the exceptions to this, but inmany instances, yes, the stock
price might be fluctuatingdramatically, even towards the
downturn, but dividendsoftentimes remain very
consistent.
So that's one of the reasonsI'm still incorporating it here.
If dividends were cut in halfanytime stock price is cut in
half, we couldn't count on themthe same way that I am, at least
(06:45):
in these examples.
So let's now go back to thethird example here.
In the third example, you stillhave that million dollar
portfolio.
It's still generating $20,000per year in dividends, but now
you need $50,000 per year inincome from that portfolio.
Well, now there's a potentialliability there of $30,000 extra
dollars above and beyonddividends that are needed from
(07:06):
that portfolio.
So if stocks drop 20, 30%,let's assume that we can still
count on that $20,000 per yearof dividends, but there's
remaining $30,000 we'd stillneed, and we don't want to have
to sell stocks to free thatmoney up.
Because, again, we don't wantto have to sell stocks when
they've dropped, especially not20, 30% or more.
So in that example, that's whenyou'd want to have enough money
(07:27):
in cash or bonds to be able tolive on.
So, essentially, somethingthat's more stable, that's not
dropped 20, 30, 40% or more.
That's why we incorporate cash,bonds, other stable assets,
into our retirement planning.
So start there.
Number one is understand what isyour target investment
allocation, and that's going tobe a function of your retirement
(07:50):
living expenses as well as yourother retirement income sources
.
So when Alan says,unfortunately, I'm weighted too
heavily in stocks and need toadd more fixed income to balance
out the portfolio, he may besaying that because he actually
went through this exercise andhas a specific investment
allocation that's suitable forhis needs.
Or he may be saying thatbecause he's retiring and just
(08:11):
by default thinks he needs amore conservative allocation.
So, alan, I'm not sure whichone it is for you.
For other listeners, I'm notsure what it is in your case
either, but start byunderstanding what is your
actual target investmentallocation by the time that you
get to retirement.
That's number one.
Hey everyone, it's me again forthe Disclaimer.
Thanks for watching.
Please be smart about this.
Before doing anything, pleasebe sure to consult with your tax
(08:32):
planner or financial planner.
Nothing in this podcast shouldbe construed as investment, tax,
legal or other financial advice.
It is for informationalpurposes only.
Number two is this when shouldyou hold those assets?
So once you've determined anallocation let's assume, for an
example, it's 80% stocks, 20%bonds what accounts are you
(08:54):
allocating those stocks in thosebonds too?
This is the concept of assetlocation.
So, going back to that example,let's assume we want 80% stocks
and 20% bonds, and let's assumethat Alan has an IRA and a Roth
IRA in a brokerage account.
Should Alan have 80% stocks and20% bonds in his IRA and 8020
(09:15):
in his Roth IRA and 8020 in hisbrokerage account?
I would say no, almostcertainly not.
It should depend upon whataccounts is Alan going to pull
from first, based upon hisspecific drawdown strategy.
So let's assume for a secondthat he's going to try to spend
down his brokerage account tokeep his taxable income low and
(09:35):
simultaneously start convertingmoney from his traditional IRA
into a Roth IRA Fairly commondrawdown approach that we'll see
.
In that case, even if hishigh-level asset allocation goal
is 80% stocks, 20% bonds, ifhe's going to be spending down
his brokerage account first, wewant that to be weighted far
more heavily towards bonds thanthe rest of the portfolio.
(09:57):
So he could still have theoverall 8020 mix, but more of
those bonds should be in hisbrokerage account and more of
the stocks should be in his IRAand Roth IRA, because it's not
necessarily are you retired ornot retired.
It's a matter of looking atevery single account you have in
understanding the role it playsin your portfolio and in your
(10:17):
drawdown strategy.
Accounts you're not going tospend down for quite some time.
Those can still be moreaggressive, even if you're in
the decumulation phase of yourspending, because it's not about
what you're doing as a whole,it's about when will this
specific account be needed andaligning your asset allocation
in a manner that's appropriatewith that.
So let's look at Alan'ssituation.
(10:39):
It sounds like Alan and hiswife have IRAs I have no idea
how much, but for a second I'mjust going to assume it's
$800,000, because this will makethe math real easy for me.
Well, let's also assume thathis IRAs are 100% stock today.
And let's also assume, forthird assumption, that he and
his spouse have determined thatthey want 20% of their
investment portfolio in bonds.
(10:59):
What would that mean right now,based on that $800,000?
It means that they would needto sell $160,000 and reallocate
it to a more stable allocation.
So cash and bonds.
That's difficult to doemotionally.
To do that all at once isn'teasy, especially after we
suffered a down year in stocks,like we did in 2022.
So it's not necessarily naturalto feel like that's an easy
(11:23):
thing for people to do to gofrom one allocation today to an
entirely different allocationtomorrow.
But here's the thing Alan justtold us he received $200,000 as
an inheritance.
If I add that $200,000 to themade up number of $800,000 in
his IRAs, then I'm assuming.
Well, now, all of a sudden,alan has exactly $1 million.
I told you I did that to makethis easy math, because now a
(11:47):
20% allocation of a milliondollars is $200,000 that needs
to be allocated towards morestable assets.
So that makes things for Alan abit easier because he doesn't
actually have to change anythingin his IRA in this example
Granted, this example is made up.
I don't actually know how muchhe has in his IRAs, but in this
example he really doesn't needto do much with his traditional
(12:09):
IRAs, at least not yet.
What he can do is use that newcash inflow to get his fixed
income allocation accounted forwithout actually having to
change any of his existingassets.
So that's just a made upexample.
As I actually go back to Alan'squestion, he says and if I'm
reading this correctly, theyneed to add another $50,000 to
$75,000 to their fixed incomeassets.
(12:29):
So what I would look at againgo back to step one.
Understand what is your targetretirement allocation.
It is $50,000 to $75,000, theactual right number to get you
there.
And then number two where doyou need to hold that $50,000 to
$75,000?
Does that need to all be inyour brokerage account?
Well, probably, if that's whatyou're going to spend down first
(12:50):
, versus are you planning tospend down IRAs or other
accounts first?
If so, you may need to have itthere instead.
So if it is truly $50,000 to$75,000, then, alan, to your
point.
Yeah, that's money that couldbe used in your brokerage
account.
And you talked about taxefficiency the way you worded
your question.
So you could either go buycorporate bonds, which are fully
(13:10):
subject to federal and statetaxes.
You could look to buy municipalbonds, which have some tax
benefits.
You could look to buy treasurybills, which have some tax
benefits.
If you're in a state thatcharges income taxes, just in
the sense that treasury bills,you're not paying that state
income tax.
So what you want to be lookingfor there is what's called the
tax equivalent yield.
Look at corporate bonds, lookat municipal bonds, look at
(13:32):
treasury bills, and they're allgoing to have different yields.
But you don't make yourdecision based upon what that
yield is.
You based your decision onwhat's the after tax amount of
that yield that you're actuallygoing to keep.
Now, this is a topic fordifferent podcasts, different
discussion.
But to Alan's point if you aregoing to allocate some to bonds,
then what kinds of bonds, whatduration of bonds, what's the
(13:55):
tax impact of those bonds.
So there are still, of course,deeper things that you need to
do once you've identified that,but that's the high level way
that I think about that.
Then, third, number three onceyou've identified what your
target asset allocation isnumber one.
Number two you've targeted theasset location, so what accounts
are going to hold the variousstocks and bonds that you're
going to hold?
Number three is what's thetiming of that shift?
(14:16):
So let's say you have a 90-10allocation today between stocks
and bonds and you want to movethat to a 75-25 allocation by
the time that you're tired.
When do you do it?
Well, this is one of thosethings where there's not a
perfect science to it.
I wish there was somesimulation or formula where you
can just plug in your numbersand you magically get the right
answer.
(14:36):
Unfortunately, that doesn'texist.
What I like to do is Itypically like to start the
shift somewhere between aboutthe five-year mark to the
10-year mark.
On the long end.
You don't want to start shifting20 years out.
20 years out.
You're just starting to get tooconservative too quickly, in my
opinion, and now there's justthe drag of being too
conservative too soon andmissing out on some of the
(14:57):
returns that you could havereceived.
You also don't want to startthe shift 20 days out.
That's far too late.
In 20 days there's just a majormarket downturn that could
happen.
That could potentially get inthe way of you retired when you
want to.
So what's the sweet spot?
Well, there's not a perfectscience to it, but think maybe
somewhere in five to 10 yearsout from retirement to actually
(15:18):
starting to subtly make someshifts.
Ideally you're not going from a90-10 allocation today to a
75-25 allocation tomorrow.
It's not the end of the world,it just subjects you to some
risk.
If you're hanging on to a moreaggressive allocation for a
longer period of time than anunexpected downturn in the
market and, by the way, I'dargue they're all unexpected,
but that unexpected downturn nowhits you in a much harder way
(15:41):
than otherwise would have.
So if you're trying to go from90-10 to 75-25 and say you've
got five years to do so, do youmake slow, gradual shifts of
about 3% change to your stock,to bond allocation each year?
Now here's another thing that Ilike to do Instead of just
selling some investments to buyothers to gradually shift my
allocation or client'sallocation, I like to use cash
(16:04):
flows to build out the targetallocation.
What this does is it means Idon't necessarily have to sell
something or at least not sellas much as something to still
gradually build up the fixedincome allocation.
So what are cash flows?
Well, they could be dividends.
So if your portfolio, forexample, is paying 2% 3% in
dividends and your goal is toshift 2% to 3% of your
(16:26):
allocation towards fixed incomeeach year, a simple way of
thinking of that is do we takethe dividends that are paid each
year and reinvest those intothe bond allocation of our
portfolio?
Same thing goes with the fixedincome allocation.
The interest from that?
Do we just continue to use thatto buy more and more bonds,
more and more fixed income oreven new 401k or IRA or
investment contributions?
(16:46):
So if you're continuing to putmoney into your portfolio, if
you have an 80-20 portfolio or60-20 portfolio or 100-0
portfolio, whatever it is youdon't have to make new
contributions to the same exactallocation as your existing mix
of investments.
So can you start to take newcontributions and use those to
slowly but surely build out thetarget allocation you're looking
(17:07):
for, so that by the time youactually retire, it's more like
you've landed a plane going from30,000 feet to 25,000 to 20,000
to 15,000 to 10,000.
You gradually landed that thing, as opposed to falling out of
the sky and hoping for the bestwhen you actually hit retirement
.
Obviously, a plane falling outof the sky is much more dramatic
than changing an investmentallocation, and there's many
(17:28):
instances where you can and youshould change an investment
allocation all that once, rightbefore you retire.
The risk of doing that, therisk of holding on too long, is
just that if there's a majordownturn in the stock market and
more of your portfolio is inthe stock market than should be
now, you face a setback thatwill take longer to recover from
than had you slowly but surelystarted shifting your allocation
(17:48):
.
And then, finally, cash flows.
In Allen's example, he justreceived an inheritance that's
$200,000.
That's a type of cash flow thatwe can't necessarily all count
on.
But if there is an expectedinheritance, or you have stock
that's vesting, or a finalpayout of PTO or vacation time
or sick leave or whatever thecase might be, factor all those
(18:09):
things in to what you can use tobuild out the allocation that
you're looking for.
So, in summary, number one startwith your actual target
allocation and do it the rightway, don't just do it because
you're retired.
Therefore, you need a 60-40portfolio.
Do it because you're trying tocome up with the right portfolio
mix for you that meets yourfinancial needs and also
(18:29):
satisfies your own unique risktolerance.
Number two find the right assetlocation.
Where should you hold differentstocks and different bonds?
And then, number three, come upwith a plan for how you will
start to build out thatallocation.
How do you get from point A topoint B?
Ideally, it's not a dramaticshift all at once, but you have
a plan that you can then actupon over the next few years to
(18:52):
get from where you are today andgradually shift that to where
you want to be in the future.
So, alan, thank you for thatquestion.
I know it's a fairly simplequestion of when should I start
making these changes, but thereis a process you should follow.
So I think it's good toactually go through those steps,
starting by taking a step backand then working through things
systematically.
So that's it for today.
(19:12):
Again, a reminder if you havenot already left a review for
this show, it would really meana lot to me if you took a few
minutes and did so, and thenalso check us out on YouTube,
the channel name is now JamesKanol.
It used to be under RootFinancial, but you can find that
on YouTube James Kanol.
With that said, thank you forlistening.
I'll see you all next time.
Thank you for listening toanother episode of the Ready for
(19:34):
Attignment podcast.
If you want to see how RootFinancial can help you implement
the techniques I discussed inthis podcast, then go to
rootfinancialpartnerscom andclick Start here, where you can
schedule a call to one of ouradvisors.
We work with clients all overthe country and we love the
opportunity to speak with youabout your goals and how we
might be able to help.
And please remember, nothing wediscuss in this podcast is
(19:55):
intended to serve as advice.
You should always consult afinancial, legal or tax
professional who's familiar withyour unique circumstances
before making any financialdecisions.
We all know it makes sense to have a different
portfolio allocation beforeretirement than you actually
have in retirement, but how andwhen do we actually go about
making that change?
That's the topic for today onReady for Retirement.
This is another episode ofReady for Retirement.
I'm your host, james Cannell,and I'm here to teach you how to
(00:20):
get the most out of life withyour money.
And now on to the episode.
Today's topic is based on alistener question, and this
question comes from Alan.
Alan says this James, I reallylike your podcast.
You always bring a lot of usefulinformation that I can
incorporate into my retirementplan.
I will be retiring in a fewmonths and unfortunately I am
weighted way too heavily instocks and need to add more
(00:42):
fixed income to balance out myportfolio.
It's my fault for not doing itearlier.
We will be getting about twohundred thousand dollars on the
sale of my mother's house verysoon.
We've already maxed out ourIRAs this year, but even if we
didn't, it would only addfifteen thousand dollars to our
portfolio.
We probably need to add anotherfifty thousand to seventy five
thousand dollars to fix income.
The only option I see is to putthat money into a taxable bond
(01:05):
fund.
We're only in the twelvepercent tax bracket, so it
wouldn't be a huge tax hit.
Any other thoughts you may haveas to where to put the bond
fund or at least how to balanceout the portfolio?
Thank you, alan.
Well, thank you for thatquestion, and essentially what
he's asking is I have myportfolio mix, but this
portfolio mix is maybe tooheavily weighted towards stocks,
(01:26):
because I've been growing myportfolio and so I've had a
stock and a growth focus.
But now I'm gonna retire and asI'm retiring, I now need to
make an abrupt shift towards anew allocation, because I'm too
heavily weighted in stocks andon top of that, I have this new
inflow of cash coming in.
How do I think about this?
How do I go from where I amtoday to where I should be with
(01:48):
my portfolio allocation?
And that's exactly what we'regonna talk about today.
Before we jump in, I willhighlight the review of the week
, and this comes from usernameAJ Dubia, and AJ says five stars
.
James discusses topics that arerelevant to aspiring retirees,
along with those of us who havealready taken the plunge.
His communication style andtopics are both informative to
(02:08):
those of us who arecontemplating retirement, but
also engaging for those of uswho are already a little more
informed and always looking tolearn more about retirement
planning.
Keep up the great work.
Five-star review.
Well, aj, thank you very muchfor that.
Thank you to everyone who'sleft reviews.
If you have not already done so, and if you've gotten any value
of this show, would reallyappreciate you taking a moment
to do that.
Also, make sure that you checkus out on YouTube, if you
(02:31):
haven't already.
The YouTube channel name usedto be root financial.
It's now just under my name,james Kanol, so you can find it
there.
Where you can find this episode, which is just the podcast, and
there's also videos we releaseevery single Saturday to make
sure that you are preparing thebest you can for retirement,
ultimately in that effort to getthe most out of life with your
money.
So on to the podcast episodefor today.
(02:54):
So how do we start to make thisshift from where we are to where
we want to go?
Seems like a fairlystraightforward answer of you
should do this five years outand you should do that three
years out, and there's someformula that you should follow,
but unfortunately, that's notnecessarily the case.
Here's actually the frameworkthat I would apply, and I would
start by taking a big step back.
Here's the order of operations.
(03:14):
I would do things in number one.
I would first ask you what isyour target investment
allocation?
Why does this matter?
This matters because so oftenwe jump right into the.
I'm retired, therefore, I needto be more conservative mindset
now.
Sometimes that is the case.
Oftentimes that's the casewhere, when you're retired, your
portfolio allocation should bea little bit more or a lot bit
(03:37):
more Conservative than yourworking year allocations, but
that's not always the case.
What you need to ask yourselfinstead is what role does my
portfolio play in creating theincome I need to create in
retirement?
So, in other words, how doesthis supplement or how does this
play along with my other incomesources, like social security
(03:58):
or pension or rental income orpart-time work or whatever the
case might be?
But what specific needs do Ihave from my portfolio?
Let's look at a super basicexample just to illustrate this.
Let's assume that Alan retiredand he has pension and a social
security benefit that combinedfor $6,000 per month.
But let's also assume that Alansays do you know what?
(04:18):
I only want to spend $5,000 permonth.
Well, in that example, alan'sportfolio or anyone's portfolio
for that matter, could be viewedas extra.
We still want to manage itcorrectly, we still want to make
sure that we're making wisedecisions with it, but he's not
dependent upon it to generatecurrent income so that he can
survive.
Now I don't know Alan's livingexpenses, I don't know how
(04:39):
there's other income sources.
It wasn't part of the question,but just using that as an
example, that's a very basicexample of when you wouldn't
necessarily need your portfolioto get more conservative in
retirement.
Here's another example.
Let's assume that you have amillion dollar portfolio and you
need $20,000 per year from itbecause that 20,000 will
supplement your social security,your pension or other income
(05:02):
sources.
Well, you look at that and whatI would look at first is what
cash income is that portfoliodelivering?
So say, hypothetically, it'sentirely in stocks, it's
diversified, it's well-spreadout, but the whole million
dollars is stocks.
Well, my guess is thatportfolio would be generating at
least $20,000 per year just incash dividends.
(05:23):
So, even though in this exampleyou actually do need some of
your portfolio, there's stillcash dividends being paid, to
the point that you wouldn't haveto sell any of your stock
investments to create income,even if there was a downturn in
retirement because, again, thewhole reason we don't have the
entirety of our portfolio instocks and retirement is there
(05:43):
will be downturns.
They happen very regularly.
Now they're temporary, but weneed to be in a position where
we're not having to sell ourstock investments to free up
cash for distribution for livingexpense needs when those
downturns are happening.
Now let's look at a finalexample.
Let's assume that you have thatsame million dollar portfolio,
but this time you need $50,000per year from it.
(06:04):
Let's assume the same portfoliois still delivering $50,000 per
year in dividends.
A quick side note, real quick,that's important to note with
this conversation as we'reincorporating dividends is
dividends that companies paytypically remain very consistent
, even if that company stockprice has fallen 20, 30, 40%.
Now there are exceptions tothis and we need to prepare for
(06:25):
the exceptions to this, but inmany instances, yes, the stock
price might be fluctuatingdramatically, even towards the
downturn, but dividendsoftentimes remain very
consistent.
So that's one of the reasonsI'm still incorporating it here.
If dividends were cut in halfanytime stock price is cut in
half, we couldn't count on themthe same way that I am, at least
(06:45):
in these examples.
So let's now go back to thethird example here.
In the third example, you stillhave that million dollar
portfolio.
It's still generating $20,000per year in dividends, but now
you need $50,000 per year inincome from that portfolio.
Well, now there's a potentialliability there of $30,000 extra
dollars above and beyonddividends that are needed from
(07:06):
that portfolio.
So if stocks drop 20, 30%,let's assume that we can still
count on that $20,000 per yearof dividends, but there's
remaining $30,000 we'd stillneed, and we don't want to have
to sell stocks to free thatmoney up.
Because, again, we don't wantto have to sell stocks when
they've dropped, especially not20, 30% or more.
So in that example, that's whenyou'd want to have enough money
(07:27):
in cash or bonds to be able tolive on.
So, essentially, somethingthat's more stable, that's not
dropped 20, 30, 40% or more.
That's why we incorporate cash,bonds, other stable assets,
into our retirement planning.
So start there.
Number one is understand what isyour target investment
allocation, and that's going tobe a function of your retirement
(07:50):
living expenses as well as yourother retirement income sources
.
So when Alan says,unfortunately, I'm weighted too
heavily in stocks and need toadd more fixed income to balance
out the portfolio, he may besaying that because he actually
went through this exercise andhas a specific investment
allocation that's suitable forhis needs.
Or he may be saying thatbecause he's retiring and just
(08:11):
by default thinks he needs amore conservative allocation.
So, alan, I'm not sure whichone it is for you.
For other listeners, I'm notsure what it is in your case
either, but start byunderstanding what is your
actual target investmentallocation by the time that you
get to retirement.
That's number one.
Hey everyone, it's me again forthe Disclaimer.
Thanks for watching.
Please be smart about this.
Before doing anything, pleasebe sure to consult with your tax
(08:32):
planner or financial planner.
Nothing in this podcast shouldbe construed as investment, tax,
legal or other financial advice.
It is for informationalpurposes only.
Number two is this when shouldyou hold those assets?
So once you've determined anallocation let's assume, for an
example, it's 80% stocks, 20%bonds what accounts are you
(08:54):
allocating those stocks in thosebonds too?
This is the concept of assetlocation.
So, going back to that example,let's assume we want 80% stocks
and 20% bonds, and let's assumethat Alan has an IRA and a Roth
IRA in a brokerage account.
Should Alan have 80% stocks and20% bonds in his IRA and 8020
(09:15):
in his Roth IRA and 8020 in hisbrokerage account?
I would say no, almostcertainly not.
It should depend upon whataccounts is Alan going to pull
from first, based upon hisspecific drawdown strategy.
So let's assume for a secondthat he's going to try to spend
down his brokerage account tokeep his taxable income low and
(09:35):
simultaneously start convertingmoney from his traditional IRA
into a Roth IRA Fairly commondrawdown approach that we'll see
.
In that case, even if hishigh-level asset allocation goal
is 80% stocks, 20% bonds, ifhe's going to be spending down
his brokerage account first, wewant that to be weighted far
more heavily towards bonds thanthe rest of the portfolio.
(09:57):
So he could still have theoverall 8020 mix, but more of
those bonds should be in hisbrokerage account and more of
the stocks should be in his IRAand Roth IRA, because it's not
necessarily are you retired ornot retired.
It's a matter of looking atevery single account you have in
understanding the role it playsin your portfolio and in your
(10:17):
drawdown strategy.
Accounts you're not going tospend down for quite some time.
Those can still be moreaggressive, even if you're in
the decumulation phase of yourspending, because it's not about
what you're doing as a whole,it's about when will this
specific account be needed andaligning your asset allocation
in a manner that's appropriatewith that.
So let's look at Alan'ssituation.
(10:39):
It sounds like Alan and hiswife have IRAs I have no idea
how much, but for a second I'mjust going to assume it's
$800,000, because this will makethe math real easy for me.
Well, let's also assume thathis IRAs are 100% stock today.
And let's also assume, forthird assumption, that he and
his spouse have determined thatthey want 20% of their
investment portfolio in bonds.
(10:59):
What would that mean right now,based on that $800,000?
It means that they would needto sell $160,000 and reallocate
it to a more stable allocation.
So cash and bonds.
That's difficult to doemotionally.
To do that all at once isn'teasy, especially after we
suffered a down year in stocks,like we did in 2022.
So it's not necessarily naturalto feel like that's an easy
(11:23):
thing for people to do to gofrom one allocation today to an
entirely different allocationtomorrow.
But here's the thing Alan justtold us he received $200,000 as
an inheritance.
If I add that $200,000 to themade up number of $800,000 in
his IRAs, then I'm assuming.
Well, now, all of a sudden,alan has exactly $1 million.
I told you I did that to makethis easy math, because now a
(11:47):
20% allocation of a milliondollars is $200,000 that needs
to be allocated towards morestable assets.
So that makes things for Alan abit easier because he doesn't
actually have to change anythingin his IRA in this example
Granted, this example is made up.
I don't actually know how muchhe has in his IRAs, but in this
example he really doesn't needto do much with his traditional
(12:09):
IRAs, at least not yet.
What he can do is use that newcash inflow to get his fixed
income allocation accounted forwithout actually having to
change any of his existingassets.
So that's just a made upexample.
As I actually go back to Alan'squestion, he says and if I'm
reading this correctly, theyneed to add another $50,000 to
$75,000 to their fixed incomeassets.
(12:29):
So what I would look at againgo back to step one.
Understand what is your targetretirement allocation.
It is $50,000 to $75,000, theactual right number to get you
there.
And then number two where doyou need to hold that $50,000 to
$75,000?
Does that need to all be inyour brokerage account?
Well, probably, if that's whatyou're going to spend down first
(12:50):
, versus are you planning tospend down IRAs or other
accounts first?
If so, you may need to have itthere instead.
So if it is truly $50,000 to$75,000, then, alan, to your
point.
Yeah, that's money that couldbe used in your brokerage
account.
And you talked about taxefficiency the way you worded
your question.
So you could either go buycorporate bonds, which are fully
(13:10):
subject to federal and statetaxes.
You could look to buy municipalbonds, which have some tax
benefits.
You could look to buy treasurybills, which have some tax
benefits.
If you're in a state thatcharges income taxes, just in
the sense that treasury bills,you're not paying that state
income tax.
So what you want to be lookingfor there is what's called the
tax equivalent yield.
Look at corporate bonds, lookat municipal bonds, look at
(13:32):
treasury bills, and they're allgoing to have different yields.
But you don't make yourdecision based upon what that
yield is.
You based your decision onwhat's the after tax amount of
that yield that you're actuallygoing to keep.
Now, this is a topic fordifferent podcasts, different
discussion.
But to Alan's point if you aregoing to allocate some to bonds,
then what kinds of bonds, whatduration of bonds, what's the
(13:55):
tax impact of those bonds.
So there are still, of course,deeper things that you need to
do once you've identified that,but that's the high level way
that I think about that.
Then, third, number three onceyou've identified what your
target asset allocation isnumber one.
Number two you've targeted theasset location, so what accounts
are going to hold the variousstocks and bonds that you're
going to hold?
Number three is what's thetiming of that shift?
(14:16):
So let's say you have a 90-10allocation today between stocks
and bonds and you want to movethat to a 75-25 allocation by
the time that you're tired.
When do you do it?
Well, this is one of thosethings where there's not a
perfect science to it.
I wish there was somesimulation or formula where you
can just plug in your numbersand you magically get the right
answer.
(14:36):
Unfortunately, that doesn'texist.
What I like to do is Itypically like to start the
shift somewhere between aboutthe five-year mark to the
10-year mark.
On the long end.
You don't want to start shifting20 years out.
20 years out.
You're just starting to get tooconservative too quickly, in my
opinion, and now there's justthe drag of being too
conservative too soon andmissing out on some of the
(14:57):
returns that you could havereceived.
You also don't want to startthe shift 20 days out.
That's far too late.
In 20 days there's just a majormarket downturn that could
happen.
That could potentially get inthe way of you retired when you
want to.
So what's the sweet spot?
Well, there's not a perfectscience to it, but think maybe
somewhere in five to 10 yearsout from retirement to actually
(15:18):
starting to subtly make someshifts.
Ideally you're not going from a90-10 allocation today to a
75-25 allocation tomorrow.
It's not the end of the world,it just subjects you to some
risk.
If you're hanging on to a moreaggressive allocation for a
longer period of time than anunexpected downturn in the
market and, by the way, I'dargue they're all unexpected,
but that unexpected downturn nowhits you in a much harder way
(15:41):
than otherwise would have.
So if you're trying to go from90-10 to 75-25 and say you've
got five years to do so, do youmake slow, gradual shifts of
about 3% change to your stock,to bond allocation each year?
Now here's another thing that Ilike to do Instead of just
selling some investments to buyothers to gradually shift my
allocation or client'sallocation, I like to use cash
(16:04):
flows to build out the targetallocation.
What this does is it means Idon't necessarily have to sell
something or at least not sellas much as something to still
gradually build up the fixedincome allocation.
So what are cash flows?
Well, they could be dividends.
So if your portfolio, forexample, is paying 2% 3% in
dividends and your goal is toshift 2% to 3% of your
(16:26):
allocation towards fixed incomeeach year, a simple way of
thinking of that is do we takethe dividends that are paid each
year and reinvest those intothe bond allocation of our
portfolio?
Same thing goes with the fixedincome allocation.
The interest from that?
Do we just continue to use thatto buy more and more bonds,
more and more fixed income oreven new 401k or IRA or
investment contributions?
(16:46):
So if you're continuing to putmoney into your portfolio, if
you have an 80-20 portfolio or60-20 portfolio or 100-0
portfolio, whatever it is youdon't have to make new
contributions to the same exactallocation as your existing mix
of investments.
So can you start to take newcontributions and use those to
slowly but surely build out thetarget allocation you're looking
(17:07):
for, so that by the time youactually retire, it's more like
you've landed a plane going from30,000 feet to 25,000 to 20,000
to 15,000 to 10,000.
You gradually landed that thing, as opposed to falling out of
the sky and hoping for the bestwhen you actually hit retirement
.
Obviously, a plane falling outof the sky is much more dramatic
than changing an investmentallocation, and there's many
(17:28):
instances where you can and youshould change an investment
allocation all that once, rightbefore you retire.
The risk of doing that, therisk of holding on too long, is
just that if there's a majordownturn in the stock market and
more of your portfolio is inthe stock market than should be
now, you face a setback thatwill take longer to recover from
than had you slowly but surelystarted shifting your allocation
(17:48):
.
And then, finally, cash flows.
In Allen's example, he justreceived an inheritance that's
$200,000.
That's a type of cash flow thatwe can't necessarily all count
on.
But if there is an expectedinheritance, or you have stock
that's vesting, or a finalpayout of PTO or vacation time
or sick leave or whatever thecase might be, factor all those
(18:09):
things in to what you can use tobuild out the allocation that
you're looking for.
So, in summary, number one startwith your actual target
allocation and do it the rightway, don't just do it because
you're retired.
Therefore, you need a 60-40portfolio.
Do it because you're trying tocome up with the right portfolio
mix for you that meets yourfinancial needs and also
(18:29):
satisfies your own unique risktolerance.
Number two find the right assetlocation.
Where should you hold differentstocks and different bonds?
And then, number three, come upwith a plan for how you will
start to build out thatallocation.
How do you get from point A topoint B?
Ideally, it's not a dramaticshift all at once, but you have
a plan that you can then actupon over the next few years to
(18:52):
get from where you are today andgradually shift that to where
you want to be in the future.
So, alan, thank you for thatquestion.
I know it's a fairly simplequestion of when should I start
making these changes, but thereis a process you should follow.
So I think it's good toactually go through those steps,
starting by taking a step backand then working through things
systematically.
So that's it for today.
(19:12):
Again, a reminder if you havenot already left a review for
this show, it would really meana lot to me if you took a few
minutes and did so, and thenalso check us out on YouTube,
the channel name is now JamesKanol.
It used to be under RootFinancial, but you can find that
on YouTube James Kanol.
With that said, thank you forlistening.
I'll see you all next time.
Thank you for listening toanother episode of the Ready for
(19:34):
Attignment podcast.
If you want to see how RootFinancial can help you implement
the techniques I discussed inthis podcast, then go to
rootfinancialpartnerscom andclick Start here, where you can
schedule a call to one of ouradvisors.
We work with clients all overthe country and we love the
opportunity to speak with youabout your goals and how we
might be able to help.
And please remember, nothing wediscuss in this podcast is
(19:55):
intended to serve as advice.
You should always consult afinancial, legal or tax
professional who's familiar withyour unique circumstances
before making any financialdecisions.
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