Timing the Market Part II: Income Needs in Relation to Portfolio Value
It’s the comment I hear most often. “I’m trying to decide if I have enough to retire.”
Considering that for every time I get a question or comment there are several other people who are staying silent, I will assume that many of you need to answer this question.
It can be a hard decision to make. Whether you have enough to retire is an objective calculation based on your needs and wants. But it’s not always easy when you have a major emotional investment in the work you’ve put in to get here.
Last week we looked at how the length of time until retirement can give you an indication of to what extent you should be invested in the stock market. Now I’m going to expand on the second of three factors that will help you determine the timing that is right for you.
Taking into account your income needs in relation to portfolio value is probably the most important consideration you should make. Once you have enough and are within a few years of retirement then it’s time you need to protect some assets, regardless of what the market is doing.
It starts with basic math. Find out how much you would like to spend on an annual basis and take that as a percentage of your total assets.
The higher percentage of income you need, the more assets need to be protected and the sooner you need to eliminate risk. And the lower the percentage of income you need, the less assets need to be protected and the less you need to worry about making quick decisions.
Here’s a quick guideline for income percentages…
5% annual withdrawal– requires that you protect a substantial portion of your assets and maintaining too much risk in your portfolio may require you to delay retirement.
4% annual withdrawal– creates an optimal blend where you need a fair amount of protection but you still have enough flexibility to maintain a strategy for continued growth and accumulation.
3% annual withdrawal– you should have no problem meeting both necessary and discretionary income needs. If income is secured optimally then a large portion of your portfolio will be available for whatever investment strategy you want to pursue.
The more you have the less you need to protect. The relation between income needs and length of time until retirement will give you a clear indication of when you should exit the market and with what portion of your total assets.
Once you have figured out what percentage of assets you need to withdraw annually you’ll know when it no longer makes sense to take too much risk. Remember, at five years you should start shifting assets toward safety, at three years you need to develop a strategy and within the last year you should implement that strategy.
In relation to the withdrawal rates above, protect yourself according to whichever category you are now in. If you are still a ways out from retirement you’ll at least have a plan in place and can use the remaining work years to bump up to a more flexible position or even decide to retire early.
Everyone has different numbers, goals and expectations. How you finally decide when to time full participation in the market will depend on your personal risk tolerance. If you are an individual that doesn’t mind risk or market fluctuation then you’ll be more inclined to cut it close on both of the first two factors. We’ll get into the details next week and that should tie it all together for you.
Enjoy the rest of your weekend…