Managing retirement income with a fixed income wedge

Just as dollar cost averaging can work to help you build assets for retirement, it can also work against you when you need to be spending your assets during retirement.  In retirement your goal is no longer purely long-term, but also includes an element of short-term spending.  Just as your time horizon is the most important factor in selecting an appropriate asset allocation when investing to prepare for retirement, it is also vital during retirement.

Consider the following asset allocation strategy.  Let’s assume you plan to withdraw 5% of your investment assets in the following year and hope to continue this for the rest of your life.  Based on your circumstances, we may agree that an initial fixed income reserve of four years of planned spending is appropriate, so your basic asset allocation may look like this, with 80% allocated to equities that are necessary for the long-term protection and growth of asset value and 20% targeted for short-term spending.  It may make sense to build that 20% portion by shifting long-term assets in the four years leading up to starting an investment income.

It makes sense to diversify the 80% equity portion to reduce fluctuations and it may also make sense to diversify the fixed income portion, with one year of planned spending in money market or short term bond assets and the rest in higher yielding income securities.  Thus, a more detailed asset allocation may look like this:

Once the initial parameters are set, we may then want to have a rebalancing policy to further smooth results and avoid the possibility of selling long-term investments during short-term period of low prices.  Thus, the fixed income wedge proportion will change depending on market conditions.  Here is a sample rebalancing policy table:

Of course, this can be customized for your individual circumstances and adapted to fit changing individual circumstances.  Some mutual fund companies now have automatic rebalancing systems that we can use to operate this asset allocation strategy and we can override it (if it seems prudent) following an annual plan review.

If you are within five years of planned retirement or are already retired and we have not discussed this type of strategy, please contact our office to schedule a meeting to discuss it.