I remember my days as a financial planner. When I worked with my clients on their retirement plans, the easiest part was withdrawals. Why? Because we were taking care of their money. In private banking, we offered an “all-inclusive” service where we would manage how, when, and where to withdraw the money to make sure our clients enjoyed their retirement.
The reality is significantly different if you manage your own portfolio. The advantage is that you are not limited by your financial advisor’s set of products, and you don’t have to pay fees. Therefore, there are good opportunities for your returns to be better. Unfortunately, once you get to be retired, you don’t benefit from the “all-inclusive” service where someone manages the mechanics behind each withdrawal.
Even if you don’t have someone taking care of your withdrawals, it doesn’t have to be complicated. This article is all about making your retiree’s life easy. The goal here is that you have more time to spend with your family, laughing, traveling, or eating out. We don’t want you to spend your weekends in front of your computer designing budgets and orchestrating withdrawals.
I’ll go with how I intend to manage my portfolio once I retire. I’ll cover the how, when, and where to withdraw money from a portfolio.
But first, a few words about taxes.
Withdrawal and Taxes
Considering that each situation is different and that I have Canadian, American, and even European readers, I will not discuss tax implications. You already know that I’ will advise you to seek professional advice on tax issues.
I believe one should perform tax optimization after he/she has set his/her investing strategy (global asset allocation, risk tolerance, types of investments). It’s good to save a few bucks in taxes, but not at the expense of the bigger picture. In other words, I don’t think it’s a crime to pay withholding taxes on dividends paid if it enables you to have a more diversified and better-performing portfolio.
However, when it’s time to retire, the order and timing of withdrawals could greatly affect your budget. You can’t control your portfolio performance, but you can control a great part of the taxes you will pay (or save) at retirement. Therefore, crunching numbers with a tax expert will likely make a big difference in your lifestyle. Make sure to make your appointment, develop a plan, and thereby avoid potential costly mistakes.
How About Inflation Protection?
I have received many questions about inflation lately. It’s understandable considering the amount of “advertisement” for the “Flations of the Apocalypse” (namely In, Stag and Hyper). Gold believers will not miss an opportunity to tell you about how much cash the FED has printed in the past twelve months. Bitcoin fans will explain that the only viable currency is digital. Finally, some go as far as comparing Canada with Zimbabwe or Venezuela and today’s U.S. with 1990’s Japan. In other words, many are calling for a massive currency value drop creating hyperinflation. This is a lot of noise that you don’t need in your life.
If you book your entire weekend to try to understand what is happening between the creation of money (stimulus bills in the U.S., support in Canada, etc.), gold prices and the rise of Bitcoin, you will have lost a great opportunity to take a walk outside and enjoy spring. Here’s my confession: I regularly read articles about those topics because it’s my job (and it’s my interest). Each time I read something that makes me think “hum…this makes sense”, I read another piece telling me the complete opposite and this article also makes sense.
Conclusion: I’m not smart enough to tell you if we are going to get into hyperinflation or not. There are multiple forces driving currencies and prices both up and down at the same time. Then, what is the smart thing to do?
How to protect your portfolio against inflation
If you search for ways to protect your portfolio from inflation, you will likely end-up on pro gold / precious metals or pro bitcoin articles. In fact, there isn’t a bullet proof methodology to protect your money against inflation. Not even gold. Did you know that since its peak price in the 80’s, gold has never fully recovered when considering inflation? I just found this gem written by Morning Star showing how gold is far from a good hedge against inflation.
Below, you will see a graph showing you how commodities (blue), Real Estate (red), equities (orange), and gold (yellow) did over the last three critical inflationary periods. Shocker: gold is the worst hedge of them all! It worked tremendously well during an episode of stagflation (inflation mixed with a recession) but appeared to be a dud for regular inflationary periods.
The article suggests commodities having the best correlation (e.g., protection) with inflation. However, you must be ready for a wild ride as it is also the most volatile asset class. Real Estate usually does well as landlords tend to pass the inflationary pressure to their tenants. Finally, there isn’t much correlation between stocks and inflation. However, long-term returns from equities tend to be superior to all asset classes. I guess this is how you can protect your portfolio against inflation, right?
I know a way to not worry about inflation though. It’s called dividend growth investing. By selecting companies with the ability to increase their dividends year after year, you protect your retirement income from inflation. In 2020, my portfolio dividend payments increased by 7.7%. That’s more than enough to cover inflation.
If I don’t know what inflation will look like in the future, I also know that capitalism isn’t about to disappear. Great companies making great products or services will continue to expand and pay dividends. If you want to fight inflation, I believe this is a classic “offense is the best defense” situation. Gold has failed many investors, Bitcoin has proven one thing and one thing only (it’s highly volatile), but great dividend growers have always performed well over the long term. I’ll bet my retirement on that too!
It is a simple answer to a complicated question. Sometimes, keeping things simple is the best strategy. Now, let’s simplify the withdrawal mechanics!
Cash, Dividends, Selling Shares and Portfolio Allocation
In this section, we’ll elaborate a simple, but effective, plan to make sure you always have enough money to enjoy your retirement. I will tell you what I intend to do once I retire. It may or may not fit with your situation, but this will give you a good starting point.
As previously discussed in the last retirement article, I intend to have between 12 and 24 months worth of my retirement budget in cash on day 1 of my “new life”. The key here is to have enough cash, so I never panic when the market drops and that I’m never forced to sell stocks at a bad time.
With this cushion in mind, I expect to combine my dividend payments with small withdrawals from this cash account. To make the example fun, let’s put numbers into this exercise.
Imagine I retire at 65 with $1,000,000 generating 2% in dividends (my current average yield). Now, let’s imagine I need the classic 4% from that $1M (or $40K/year). This means that between two and four years before retirement, I would have let the 2% dividend pile up in cash to create my reserve. I don’t want to be forced to sell stocks at 65 during the 33rd pandemic wave crushing the stock market ?.
Therefore, at the age of 65 I would have a portfolio of $1M generating $20K in dividends and I would also have $40K in cash. I would review my financial situation every 6 months to determine if it’s the right time to sell some shares or not.
During the first six months of retirement, I would have spent about $20K. Half of it will come from my dividend portfolio and the other half from the cash account. Therefore, my cash account would decrease to $30K. If after 6 months the market is still good (e.g. no crash happening), I would sell a few shares to increase my cash account back to $40K.
If the market is in “crash mode”, I can easily wait another 6 months and see where the market is at that time. At this point, my cash account would decrease to 20K and my portfolio would still be generating the same $20,000 in dividends. In fact, chances are it will be generating a little bit more than that since my portfolio is focused on dividend growth stocks.
A market crash doesn’t drop the value of your portfolio permanently. Most crashes will happen over a few months to a year and then the market will start to recover. If the market is still in bad shape after 1 year of bearish returns, I still have the luxury to do nothing and wait another 6-months using the same technique. Ultimately this strategy would give me up to two years without having to touch my portfolio.
Can You Protect Your Cash Account for More than Two Years?
A two-year break will be enough to cover many bear markets, but not all of them. Therefore, it’s preferable to have two-years worth of retirement budget to cover about four years of bear market. If you don’t want to have ~$80K sitting in a cash account as per my example, there is something else you can do.
It’s always possible to take a few chances with your portfolio and improve your yield. Let’s be honest, a 2% yield isn’t much. It’s quite easy to transform your dividend yield from 2% to a 3-3.5% level. By using my DSR PRO portfolio builder, I can sort my holdings by yield and identify which company “hurts” my yield:
I can then identify each sector where I must find replacements and use the stock screener with filters such as:
- PRO rating* minimum 4
- Dividend safety score* minimum 4
- Dividend yield minimum 3%
*I’ve explained both the PRO Rating and the Dividend Safety Score on my YouTube channel. Click on each ranking title to view them.
I could then sell some Visa, Tecsys, Apple, Alimentation Couch-Tard and buy more Royal Bank, Sylogist, Broadcom and Coca-Cola.
Another technique I could use is to look at my sector allocation. I have a strong concentration in technology and consumer cyclical. I could sell some stocks in those sectors and replace them with companies in sectors with higher yields such as REITs and Utilities.
Therefore, I would end-up with two valid scenarios (you can pick the one you like best):
- Portfolio yield of 2% and a larger cash reserve (more like 18 to 24 months)
- Portfolio yield of 3%-4% and a cash reserve of about 12 months.
Since I’ve always focused more on growth than on income, I would likely pick the scenario #1. However, this would expose my retirement plan to more volatility in the case of a severe market crash. Scenario #2 would allow your portfolio to recover fully from pretty much any bear markets while you enjoy a stronger current income coming from your portfolio.
At this point, it’s a personal choice between growth and income. I see both possibilities as good choices (if you don’t jump from one to another repetitively!).
Which stocks to sell?
If I must sell stocks to create my own dividend, I will likely do everything to keep my sector allocation intact. I would then identify if I must rebalance my portfolio first and sell overweighted stocks. If sector allocation is well diversified, then I would sell a few shares of each position to maintain the allocation as is. It may trigger a few more transaction fees, but that’s the point of not selling more than twice a year (or, ideally, once a year).
Here’s an easy plan to follow for your retirement withdrawals:
- Select between a low yield portfolio with a larger cash reserve or a higher yield (3-4%) and about 12 months of cash reserve.
- Write down a tax optimization plan with a tax expert.
- Sell overweight stocks to rebalance your portfolio, then sell a little bit of all positions to maintain your sector allocation.
- Enjoy your retirement!
When I made the decision to travel for one year with my family, I had this sentiment of urgency to act. While we worked on this project for 18 months before leaving, I was very aware that many kinds of catastrophes could hit our family. I feared an external event would take my dream away. In the end, it was the most amazing experience of my life.
When you retire, you may experience a similar feeling. The fear that an external event could destroy your retirement dream is frightening. But in most cases, it’s just our brain playing tricks with us. If you have a robust plan, you simply must follow it, and everything will be fine. Keep in mind that full market cycles take between 5 and 10 years on average. Therefore, even in retirement, you are down for a least 2 full cycles.
Good article, Mike. This makes a lot of sense and takes “fear” out of the equation (stick with your plan!). My only rebuttal is to use higher-yielding stocks (such as utilities) to improve average yield above 2%. For your age group that makes total sense, but for people in their 60’s and 70’s they likely want a higher yield than 2%.
Keep up the good work, Mike.
You are right, it’s “easier” to get a 5% yield on a stock. But at retirement, I’ll prefer to sell a few shares of my MSFT than buying AT&T 🙂
Two different approaches, both can work.
This is a very nice strategy, I like it. Covers a lot of bases simply but effectively.
Michael James had a good life long plan the other week as well. 2 different approaches but both good.
From a few things I’ve been researching lately, I really believe you need to plan multiple things out at least 5+ years back from your retirement date, especially if you have a big RRSP, I’m Canadian (Roth/IRA in the US) to draw down. There are so many details. When to draw down, when to take CPP, OAS, I’ve seen some people do some tricks with their GIS. To make sure your taxed only as much a you have to be and have strong income flow if you are lucky to live many years past standard retirement age. I didn’t realize how many rules there are and the impact of making a mistake early in your plan.
Like you I watch a lot of YouTube or read articles about the future. But I also see (with my own real life research) within the yearly prospectus and dives into a growing number of companies are changing their culture from within.
I predict by 2030 investing will be different. The push for ESG investing you hear everywhere, is forcing companies to address pressures to change their focus from Shareholder investing principles to Stakeholder investing ones. The “stakeholder’ words have even come out of our Finance ministers mouth directly as well. I don’t want to be the “tin foil hat guy” but there are signs of this right inside the available company information we can read today. Look at for example the proposals requested of Laurentian Banks shareholders meeting and the wording in them. Also RNW and Capital Power CPX in similar ways. This will impact our portfolio’s. Like you, I have a focus on dividends or distributions. I wonder if those may be in jeopardy because of pressures from “Abigale Disney types” exerting social pressures. Let’s face it these social pressures seem to be winning these days.
As for metals, I only look at metals as a kind of insurance rather than something you make money on. If I was a Venezuelan, If i had a bank account where the value of my labor was held in gold or silver (in a OneGold or Goldmoney account even) rather than bolivars, before the currency started to meltdown, I would certainly look at its (metals) value differently in that situation. The fluctuations of metals are nothing compared to your currency imploding. I’m not sure if a native Venezuelan could hold dividend stocks outside their country, and if they did if they were super taxed on them cashing them in and buying food or toilet paper for $12 bucks a roll. Be interesting to know that?
Sorry a lot of different thoughts here.
Thank you for your thoughts, a lot of good things to consider :-).
I think the key is to have a plan and to review it periodically. There are many ways to retire happy and stress free 🙂
You are right about Venezuela, let’s hope Canada and the U.S. don’t go there!
Once again Mike, great article.
My wife and I have been retired now for about 8 years. Interesting about your 2 scenarios. What we did is use your 1st scenario with my wife’s account and your second with mine. As expected, my wife’s account gets a little better return in value, but we have to watch the cash more closely. (about 2 to 3% dividends). Mine is about 4% + in dividends. We have cash for a little more than 1 year.
Good news is that after 8 years, we’ve got about the same principal as what we started with. Almost no fees and having full control makes a huge difference.
Wow! that’s amazing (having the same principal 8 years later 🙂 ). We surely had a good run too!
It’s great to hear from someone applying the strategy too!
I don’t understand this approach. It seems to be based entirely in market timing. When the market goes down 20% and yiu choose to wait 6 months to take your money out what makes you think it won’t be down another 20 by then. In which case yiu should have taken it out previously. Conversely if the market is up 20% and yiu decide now is a good time to take it out. What makes you think it won’t be up another 20% in 6 months. In which case yiu should have held on. And what do you consider a “bad” time. Down 10. Down 20. No one knows. Just take the money out when yiu need it and stay invested as much as possible until then. Leaving a cash reserve just depletes your investment earning potential.
If you study the impact of withdrawals during a market crash, you will notice that it greatly affects a retirement plan. For example, someone who retires right before the 2008 market crash and starts withdrawing vs someone who retires one year later would have completely different results with their retirement plan.
This strategy enables you to wait a while before selling shares if you must sell shares. The key is to maintain a level of cash to reduce stress. If you don’t mind market fluctuations and you sleep well at night with them, you can definitely sell just when you need money.
Some portfolios will generate enough dividends you won’t even have to sell shares.
I like your strategy and you explained it very well, but what about the trap “Don’t cut the branches that produce apples”? Won’t the portfolio start generating fewer dividends since you’ll take all the dividends in cash PLUS you will begin to sell the shares as well? I think it depends on each person’s optimism regarding the expansion of stock prices as well as DGR. Of course, if your $1m example is in addition to a 401k, then you should be golden. Dividends come from one portfolio and you sell shares of funds out of the other portfolio. If not, maybe you could write another article and expand the mechanics of how the ‘cutting branches’ piece will work out over 25-35 years in your scenario.
You brought some great points.
We have two complete newsletters at DSR about the mechanics of withdrawals with scenarios. I just posted a small portion on this blog.
The strategy of selling shares to create your “own dividend” is based on a total return approach. You can compare the past 10 years of the total return of Alimentation Couche-Tard (low yield, high capital growth) vs Canadian Utilities (higher yield, lower capital growth). This will give you an idea :-).
I totally agree with your approach.i have my portfolio built on div. growth stocks . But, i look at stocks with at least a 4 per cent yeild and a 5 percent increase. I am averaging 4.9 percent yeild right now, so on a million dollar portfolio i can withdraw the div payout (49000.00) ,have my income increase by 2500.00 a year and still never tough my principal
Thank you for stopping by!
Wow, you are well set, congrats on your achievement!
With this setup, you will be covered by inflation and you will protect your capita. This is amazing!