Retirement Planning Part 3: Portfolio Management

Portfolio Management in Retirement

Company retirement plans continue to shift away from pensions, and towards vehicles such as the 401(k).  This shift is essentially transferring the responsibility of creating an income stream in retirement from the company, to the individual retiree.

This article discusses important factors for a retiree to consider when creating an income stream from a diversified portfolio of stock, bond, and cash investments.

Academic research regarding portfolio management has mostly centered around performance relative to risk, and balancing this dynamic through diversification across asset classes, or varying types of stock, bond, cash and other investments.

When we enter retirement and need to create a stream of income from a portfolio, two more factors need to be entered into the equation:

Liquidity and Flexibility

Liquidity is the ability to sell any investment within your portfolio, at any time, with relative ease.

Money markets, mutual funds, exchange-traded funds, most common stocks, and most individual bonds are very liquid and easily sold in secondary markets.

Investments that are not easy sold include physical gold, real estate, privately held real estate investment trusts (REITs), annuities, ownership in private companies, collectibles, low volume investments, and several types of options and futures contracts.

Flexibility is structuring a portfolio that can easily adapt to any number of changes a retiree could face including changes to monthly income needs, increased inflation, unexpected one-time withdrawals, and significant movements in stock markets either up or down.

Portfolio liquidity can be achieved through a portfolio of well diversified liquid investments, and to create a flexible portfolio we can use The Bucket Theory.

The Bucket Theory

The Bucket Theory is segmenting your portfolio by time frame based on liquidity needs.  Here is an example of a balanced portfolio separated into buckets by time frame:

Bucket #1 – Under 1 Year Bucket #2 – 1 to 5 Years Bucket #3 – Over 5 Years
5% Portfolio Weight 45% Portfolio Weight 50% Portfolio Weight
Cash Short/Intermediate Bonds Stocks for Growth

Using this flexible portfolio structure, your immediate income needs are met with the first bucket exclusively in cash.  If you have an unexpected one-time withdrawal, you have the ability to choose which bucket to take this withdrawal from based on market conditions.

As an example, during a down market you may lean towards taking a one-time withdrawal from bucket #2, so as not to have to sell stocks when they are down.

During an up market, you may lean towards taking a one-time withdrawal from bucket #3, so as to lock in these market gains, and rebalance your portfolio back to your 50/50 target.

Additionally, funds can be moved between buckets based on market conditions, changes in liquidity needs, and changes in bond interest rates.

While quality, diversified investments form the foundation of a portfolio, liquidity and flexibility provide a retiree the ability to navigate markets, and income needs throughout retirement.

Retirement Planning Part 1: Partnering with a Financial Planner

Retirement Planning Part 2: Asset Consolidation


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