New retirement investing idea: It’s safer to keep more in stocks

We all know  that the older we get, the more of our money should be kept safe. To achieve that, we gradually lower the percentage of savings we hold in stocks and increase our commitment to bonds. That’s classic, standard investment advice.

But I’m starting to think that’s wrong.  Quality bonds and certificates of deposit aren’t paying much these days. The nore we depend on interest-rate investments, the more likely it is that we might run out of money in our older age. It might be safer to gradually hold more money in stocks, rather than less, after we retired.

When I first heard that idea, I said, “Nuts. High risk.” But new research by Michael Kitces, director of research for the Pinnacle Advisory Group in Columbus, Md., changed my mind. It turns out to be a low-risk approach that could make your retirement savings last longer and, potentially, leave more for heirs. I’m now looking at retirement investing in a whole new way.

Think of it as a “three-bucket” strategy, Kitces says.

In one bucket you hold cash to help cover your expenses for the current year. That’s grocery money. Keep enough pay any bills not already covered by other income, such as Social Security, pension or part-time work.

In the second bucket, you own short- and intermediate-term bond mutual funds, with dividends reinvested. You gradually add to your bonds during your pre-retirement and immediate post-retirement years. By age 65 or so,  these first two buckets might hold 70 percent of your retirement investments. Every year, you take money from the bond bucket to replenish your cash. With a proper withdrawal strategy, discussed below, the money in your bond funds could last 15 years or longer.

The remaining 30 percent of your money goes into a third bucket, invested in mutual funds that own U.S. and international stocks. All dividends are reinvested. You don’t expect to touch these funds for 10 to 15 years.

As time passes and you sell bond shares to pay your expenses, the amount of money in your bond bucket shrinks. As a result, the percentage of your savings that you hold in stocks will gradually rise. There’s no reason to sell stocks in bear markets because your bond funds are covering your living expenses. In fact, your fund’s dividends will be buying you more stocks cheap. By the time your bond bucket runs low, your bucket of stocks will have grown in value, maybe by a lot. That’s money for your later years.

When withdrawing cash from your bond funds, follow the 4 percent rule for making money last for life. Start with an amount equal to 4 percent of all your savings (counting both stocks and bonds) and raise it by the inflation rate in each subsequent year. For example, say you have $100,000 — $70,000 in bonds, $30,000 in stocks. Your first withdrawal would be $4,000, and would rise from there. (If you take more than 4 percent, your savings might run out too soon.)

What makes this three-bucket strategy low risk? First, your bonds secure your grocery money for at least 15 years. Second, if the market crashes when you first retire, you have only a modest amount in stocks and can afford to wait for a recovery (people who sold after the 2008 crash came to regret it). Third, owning growth investments makes it less likely that your money will run out.

When you think about it, Kitces’s approach echoes the rules of thumb that younger investors live by: Keep short-term money safe and invest long-term money for growth. Think of your first 15 years of retirement as “short-term, safe.” Let the rest of your money grow, to pay for the later years of your life.


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David // 01/28/2014 at 1:24 am

I agree with your bucket #1, but can’t get comfortable with #2. I don’t need to touch my investment accounts now, but if I did the idea of withdrawing 4% (more than those bond funds earn) seems so wrong. I bought utilities, tobacco, and other consumer staples when the prices were lower and before the extreme run-up of 2013. Subsequently, I read a note from Bill Gross in which he said that at that time he thought bond alternatives were offering better yields than bonds. I looked at my portfolio and realized that I had just that, bond alternatives. My traditional IRA average dividend yield is 8.5% and the dividends increase frequently. It seems to me that is a better candidate to which to apply a 4% rule. In addition, when I turn 70 1/2, I believe I will be able to pay my required minimum distribution, RMD, from those dividends and never touch the principal. Speaking of principal, mine is up anywhere from 50% to 100%+. Principal never increases for bonds.
Yes, I hear the risk threat that my stock principal is not secure. It could go to zero, though if we are being honest, when my stocks go to zero, your bonds will likely default, too. At least I will have collected 8%+ dividends while you collected 0.3-3.0% interest from short to medium term bonds. If we ever return to the days when bonds paid reasonable interest and were not guaranteed to go down in price, I will reconsider putting some money in bonds.
If someone is just now investing, 2-7 year bonds may be a better bet than investing in stocks that are falling with no clue as to how far they will fall. But, I would not want to withdraw 4% from those bond investments until they are actually yielding 4%. That seems like carrying a balance on a credit card. As you eat into the principal of your bond bucket, you are losing principal that you may need should God decide he doesn’t want you until you are 103. There is a cost in lost future interest earnings when we spend principal. It is very similar to the way paying credit card interest/debt service reduces spendable/savable income. So if I invested in bonds yielding 2% on average, I would not want to withdraw more than 2%. Then if God takes pity on the rest of humanity and takes me early, my heirs will have an inheritance to add to their pots of money.
Kidding aside, I would like to understand why I should consider selling some of my stocks and putting that money in bonds, now.

Jane // 02/18/2014 at 2:11 pm

I have no quarrel with anyone who cam live comfortably on dividends without ever touching principal. You will leave a fortune behind for your heirs and they will appreciate it. The 4 percent rule is for people who don’t have enough savings to live only on dividends, or whose standard of living would be squeezed by trying never to touch principal.

Jim E. // 02/03/2014 at 10:52 am

First, many thanks for your advice. My retirement funds are largely in TIAA-CREF. How would you characterize the TIAA (“guaranteed at 3%”) in this bucket strategy? Not an equity fund, but mid-term bond fund? money market-like? Something else? Thanks, again.

Jane // 02/18/2014 at 2:15 pm

I’d put it in the bond bucket. You can also use it to buy a lifetime annuity if you need an income guarantee. Some TIAA holders who want to annuitize move a bit of money into the annuity quarterly, to dollar cost average the purchase. If you don’t want to annuitize, call it “bonds”

Rosanna // 02/05/2014 at 11:13 pm

Jane, this sounds like an interesting plan. But there’s a big “what if” that I cannot help but worry about: What if the market crashes after you have depleted the first two buckets of safe money? What if the market crashes when you have no choice but to start withdrawing the money from the stock market bucket? It might have been growing perfectly fine for 15 years but then, boom, right when you need it for your living expenses, the market drops 50%. You have no time to wait for a recovery before withdrawing money from that bucket. What then?

Jane // 02/18/2014 at 2:21 pm

If stocks do fine for the first 15 years of your retirement, you will have a very large stock bucket to work with. Also, your lifespan will be 15 years shorter. You would probably be able to weather a market drop pretty well. However, Michael Kitces says that most of his clients who use this plan don’t intend to completely deplete the safe bucket. Close to the end, they expect to take some of their profits and put them into the bond bucket.

Bill // 02/09/2014 at 6:16 pm

But what if the market crashes just before you need to start using money from the stock mutual funds? It seems like you might be left short in this scenario, assuming your retirement lasts another 10-15 years.

Jane // 02/18/2014 at 2:27 pm

See my reply to Rosanna, below.

Jerry Nagler // 02/10/2014 at 9:27 am

Very wise and thoughtful article!
How much of one\’s portfolio should be in equities each year AFTER the first fifteen years of retirement?
How about just keeping 30% in equities forever if one is afraid of letting it go to a higher or lower percentage?
Is there a minimum percent that should always be kept in equities,say even after age 90+?
Thank you. Looking forward to your reply.

Jane // 02/18/2014 at 2:26 pm

You can keep 30% of your portfolio in stocks and, provided that you stick with a 4% withdrawal rate, all should be well. The alternative strategy builds up a much higher rest egg for you later years. Below 20 or 25% stocks, you run a greater risk that, at a 4% withdrawal rate, your money won’t last for life. As for equities at 90+, what do you intend for the money? If you need it for bills, I’d most an appropriate amount into something safe. If you don’t need it for bills, you are managing it for the next generation, so can go for growth.

Jane // 02/18/2014 at 2:07 pm

Actually not, Jim. My bond story said that, if interest rates rise, long-term holders of bond funds will be compensated by rising interest income. I have also written in the past in favor of declining equity holdings at older ages. My stock story said that new research had come to my attention, making a case for rising equity holdings. When I find new research that challenges conventional wisdom, I report it. For the record, as a wrote a couple of months ago, I’m in the camp that believes the economy will continue to expand.

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