Cashing In on Retirement

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In this month’s Money magazine there is an article by Penelope Wang about how much cash you should have as you enter retirement called “How Much Cash is Too Much.”  In the article Ms. Wang talks about the need to balance safety and growth.  Take too much of a risk and a sudden market plunge could wipe out half of your portfolio, which could be a disaster if you were just starting retirement.  Put too much in cash, however, and you won’t see the growth you need to sustain you through a long retirement.  Remember that inflation is constantly eating away at your buying power even if your account balance remains unchanged.

Marc Freedman, a financial planner cited in the article, recommends keeping no more than a couple of years worth of spending needs in cash, split between bank assets and short-term bonds.  This assumes that you have a pension or other source of income like an annuity to pay for basic expenses.  (Note that I would not even include Social Security in your calculations with the government more than $17.8T in debt.  Some thing needs to happen at some point and you won’t want to be relying on a check from Uncle Sam when it does.)  The idea here is that if there is a market correction like in 2008, you would have enough cash to hold on until the market recovered without needing to see stocks at fire sale prices.  Personally I would keep maybe four or five year’s worth of expenses in cash because while the markets normally recover within a year or two after a fall, sometimes stocks languish for a longer period of time, particularly if the government tries to “help” the economy through regulation or economic actions.

He also recommends budgeting for “unplanned expenses.”  The article cites an example of an adult child moving back into the home.  While I understand that things happen in life, it seems that by the time one is ready to retire, children should be at least into their thirties.  It seems like they should be able to contribute to the household income, at least enough to cover the extra money you’ll be spending for food and utilities because they are there.  Just because they move back in doesn’t mean they are suddenly 12 years old again and you should pay for everything, but I digress.  Other unplanned expenses could be things like a medical procedure that requires money for the deductible, a car breakdown requiring the sudden replacement of a vehicle, or home damage from a  fallen tree.  Certainly keeping some extra money on hand should something like this happen right after a market meltdown would be wise.

In keeping “cash,” you should still do all you can to help preserve it from inflation.  One idea would be to stage it so that money you do not need soon is allowed to make additional interest through the use of longer-term cash assets.  For example, you might place the money you need within the next year in a money market fund.  Money needed for year two could be placed in a one year CD.  Money needed for year three could be placed in a 2 year CD.  Money needed for years 3-5 could be placed in longer-term CDs or perhaps bonds that expire at appropriate intervals.  In this way you are preserving a high level of safety but getting a better return than you would in a money market fund (or placed in a shoebox under your mattress) by agreeing to lock the money in for a period of time.

Another consideration is the security of the accounts.  While government insurance protection has gotten more generous since 2008, you might still consider spreading the money out into a couple of different banks.  If there were some sort of credit crunch at one bank, it might take a while to get your accounts restored.  Having two or more banks reduces this risk.  This would also provide some level of protection from account take-over fraud and other types of identity theft since your money would not all be in one place.

Another thing to consider is the amount of assets you have when you enter retirement.  An individual with less than $500,000 in assets is taking a big risk of running out before the end of a long retirement.  Such an individual also wouldn’t be able to invest a significant portion of their money in  stocks or other volatile assets because they could not withstand a large drop in value.  For such an individual, something like an annuity may make sense since at least it guarantees a level of income.  There would also be the issue of medical bills, which can easily reach $250,000 in retirement, but relying on the generosity of the public and using Medicaid might be the only option here.

An individual with $1 M in assets is on the border line where a portion can be invested to gain a better return.  An annuity could still be purchased with a portion of the portfolio if desired for guaranteed income, although a price would be paid for that income since insurance companies don’t issue products that they don’t, on average, make money.  Such an individual would also want to have an ample cash reserve of four to five year’s worth of expenses to guard against market declines since a 50% drop would place them int eh same place as the person with only $500,000.

An individual with $2 M or $3 M starts getting to the point where a good portion could be invested.  He could treat the first $1 M as did the individual with only $1 M total and then take the additional millions and invest fully.  On years when the market does well, he could add to his cash pile and increase spending.  On bad years he could sit pat and wait for a better year.  At some level of net worth, maybe $5 M or more, a smaller cash reserve than seevral years could be held since even if there were a significant market decline the individual would still have ample assets to cover living expenses.  This is why it is important to save and invest for retirement early so that you will have more than enough.  This leads to a much more comfortable retirement than can be had living right on the edge since you can take more risks and get higher returns.

A final consideration when going into retirement is cutting recurring expenses to the minimum.  Certainly you should pay off your home so the only thing you need to pay each year to stay in your home is property taxes.  You also might consider scaling down in home to cut the costs of maintenance and taxes.  Any credit cards should be paid off and consumer loans retired.  If all you really need to buy is food, clothes, utilities, and medicine it will allow you to cut spending drastically should the need arise.

Proper cash management when going into retirement is critical, particularly during the first few years when a market downturn could seriously jeopardize your chances of making your money last.  It is much more difficult than when you are young and building wealth.  Probably the best thing to do is to build up a more than ample portfolio of assets to make it through.

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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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