One of the biggest problems in retirement planning is turning a pile of money into a reliable stream of income. I have read hundreds of articles about this topic, and I have not yet found a perfect solution to this problem. Everything has pros and cons: stocks, high-dividend stocks, bonds, annuities, real estate, and so on.
The imperfect (!) solution I chose is to first build a portfolio designed for total return and enough downside protection such that I can hold through an extended downturn. As you will see below, the total income is a little under 3% of the portfolio annually. I could easily crank out a portfolio with a 4% income rate, or even 5% income. But you have to take some additional risks to get there. With a total return-oriented portfolio, I am more confident that the (lower initial) income will grow at least as fast (and hopefully faster) than inflation.
Starting with a more traditional portfolio, I then try to only spend the dividends and interest. The analogy I fall back on is owning a rental property. If you are reliably getting rent checks that increase with inflation, you can sit back calmly and ignore what the house might sell for on the open market.
I track the “TTM Yield” or “12 Mo. Yield” from Morningstar, which the sum of a fund’s total trailing 12-month interest and dividend payments divided by the last month’s ending share price (NAV) plus any capital gains distributed over the same period. (Index funds have low turnover and thus little in capital gains.) I like this measure because it is based on historical distributions and not a forecast. Below is a very close approximation of my investment portfolio (2/3rd stocks and 1/3rd bonds).
| Asset Class / Fund | % of Portfolio | Trailing 12-Month Yield (Taken 3/15/19) | Yield Contribution |
| US Total Stock Vanguard Total Stock Market Fund (VTI, VTSAX) |
25% | 1.81% | 0.45% |
| US Small Value Vanguard Small-Cap Value ETF (VBR) |
5% | 2.03% | 0.10% |
| International Total Stock Vanguard Total International Stock Market Fund (VXUS, VTIAX) |
25% | 2.89% | 0.72% |
| Emerging Markets Vanguard Emerging Markets ETF (VWO) |
5% | 2.63% | 0.13% |
| US Real Estate Vanguard REIT Index Fund (VNQ, VGSLX) |
6% | 4.21% | 0.25% |
| Intermediate-Term High Quality Bonds Vanguard Intermediate-Term Tax-Exempt Fund (VWIUX) |
17% | 2.86% | 0.49% |
| Inflation-Linked Treasury Bonds Vanguard Inflation-Protected Securities Fund (VAIPX) |
17% | 3.09% | 0.53% |
| Totals | 100% | 2.67% |
Using this metric, my maximum spending target is a 2.67% withdrawal rate. One of the things I like about using this number is that when stock prices drop, this percentage metric usually goes up… and that makes me feel better in a gloomy market. When stock prices go up, this percentage metric usually goes down, which keeps me from getting too happy. This also applies to the relative performance of US and International stocks. In this way, tracking yield adjusts in a very rough manner for valuation.
We are a real 40-year-old couple with three young kids, and this money has to last us a lifetime (without stomach ulcers). This number does not dictate how much we actually spend every year, but it gives me an idea of how comfortable I am with our withdrawal rate. We spend less than this amount now, but I like to plan for the worst while hoping for the best. For now, we are quite fortunate to be able to do work that is meaningful to us, in an amount where we still enjoy it and don’t feel burned out.
Life is not a Monte Carlo simulation, and you need a plan to ride out the rough times. Even if you run a bunch of numbers looking back to 1920 and it tells you some number is “safe”, that’s still trying to use 100 years of history to forecast 50 years into the future. Michael Pollan says that you can sum up his eating advice as “Eat food, not too much, mostly plants.” You can sum up my thoughts on portfolio income as “Spend mostly dividends and interest. Don’t eat too much principal.” At the same time, live your life. Enjoy your time with family and friends. You may be more likely to run out of time than run out of money.
In the end, I do think using a 3% withdrawal rate is a reasonable target for something retiring young (before age 50) and a 4% withdrawal rate is a reasonable target for one retiring at a more traditional age (closer to 65). If you’re still in the accumulation phase, you don’t really need a more accurate number than that. Focus on your earning potential via better career moves, investing in your skillset, and/or look for entrepreneurial opportunities where you get equity in a business.
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I am 65 and been retired for 3 years and I’m basically doing your plan. We set our withdrawal rate at 3% which is our yearly spend. We essentially use one 60/40 fund, S&P index fund and iBonds. Note, we do not have pensions and only one of us has taken SS. I’m trying to wait until 70 for SS.
Interesting, thanks for sharing.
Quick question – don’t you have I Bonds and retail CDs as well? Do you just consider those your emergency fund or are they rolled into somewhere else on here? Thinking that those would help to increase your WAVG yield a bit.
I have some CDs but negligible. Since I’ve owned iBonds since the late 90s, I consider them cash and an emergency fund. As we get older, our main goal is simplicity. We travel a lot and I rarely look at the stock market during that time.
For me, the I Bonds are now considered part of my long-term portfolio. I thought they might serve as an emergency fund but in practice I’ve never sold one and there is a lot of deferred taxes built up so that I wouldn’t really want to sell them until I’m in a lower tax bracket.
The retail CDs are a mix. I basically keep at least a year of expenses in bank deposits. The rest which are usually in long-term CDs at 4% are considered part of the short-term bonds.
This calculation is mainly a quick estimate, the amount of CDs and I bonds aren’t significant enough to sway the numbers too much.
Jonathan,
I have not sold any of my iBonds either because I’ve not needed to. We do keep some money in cash but not a years worth.
I know timing the market is a bad idea but I am just not sure if I should put the 50 k cash i have sitting in the savings account to a brokerage account
especially with valuations already so high.
FYI, i have maxed out all other tax-advantages investments, 401k, roth. hsa.
“one of the things I like about using this number is that when stock prices drop, this percentage metric usually goes up… and that makes me feel better in a gloomy market. ”
This is what is known as the “Yield Illusion”…i.e. you think yields will remain in a down market but dividend cuts are more likely to happen.
The dividend amount will probably drop in a down market, but I don’t think it will drop more than the actual price of the market. For example, in 2008/2009 I believe the SP 500 dropped by 50% but the dividends were cut by 25%.
I try and keep things as simple as possible. VBR is a small part of VTI and ditto for VWO and VXUS. Do you get much of a benefit from exposing more of your portfolio to smaller/emerging companies? If VBR was rolled into VTI you’d be looking at ~0.54% yield contribution instead of the 0.55% currently from the two. Same questions WRT VNQ and REITs.
I think if you can handle the simplicity, you should definitely keep things simple. I’m afraid I can’t help myself, I want to wring out a little bit of extra return if I think I have a probabilistically decent chance of doing so. VBR is not reaching for yield, it’s hoping for smaller cap and value companies to have a higher total return over the long run. The higher yield is just a secondary result. Same with REITs. Primary goal is higher return w/ a little diversification. Secondary result is higher current yield.
I like the approach. Do you ever intend to draw down the capital portion? If you just spend the dividend yield, then in theory as businesses grow your capital will go up?
Yes, ideally the dividends should grow with inflation, enough to offset the fact that if I spend all the bond interest the remaining par value will be worth less every year with inflation. So I’ll have to put more money into bonds in theory to rebalance. If the income increases more than my spending, then I suppose that’s a good problem to have. Charity, more fully-funded college savings plan perhaps. It’s also possible that the natural income might drop and I will have to withdraw more than this number.