Tom Discusses Specific Versus Structured Withdrawals
Transcript:
Easan Arulanantham:
In the past, you talked about Systematic Withdrawals. Why do you prefer Systematic Withdrawals, over strategies like the Bucket System? The Bucket System is the idea where you break out your account or assets into three categories. You have a short term bucket, which is keeping cash in your bank for one or two years of expenses. Then you have this is medium bucket, which is kind of your fixed income products, with bonds, CDs; there for two to 10 year time horizon. And then you have a growth portion, which is your stocks or anything that’s 10+. And then, when a bucket gets depleted, you pull money from the bucket just above it, essentially. So your cash is running low, you pull from the bond buckets.
Tom Vaughan:
Yeah, I guess we use sort of a modified version of pure Systematic Withdraw. Because what we always do, is we try to identify how much money they really need in cash, in the banking system. And if they happen to have excess, we do use that first, because it’s practically free. There’s no taxes on it really, because you can sell it without capital gains. And it’s not paying anything right now, either, right? I mean, nothing’s getting an interest rate that’s worth much, in the banking system. And then you would… just to be clear, then you would use the Systematic Withdrawal process, which is where you would have a portfolio that is designed to match your risk tolerance. So let’s just say we go through the process, we look at how much things have fallen in the past, and all the different things that we do to try to identify the correct portfolio for the right person; and let’s just say it’s a 60% stock and 40% bond. So first, we use their money market: The cash, banking assets, to live off of; until that got down to the level of the emergency funds that they want to make sure they keep, so we’re not going to touch that. If during that time, more cash comes in; then we use that too, right?
But once we get down to emergency money only, alright? Then we would move over into taking money systematically out of the 60/40 bond portfolio; and we just keep a certain slice in the money market, and then distribute that usually monthly. Then the money market will shrink back down, and then we rebalance the 60/40 portfolio. So we’re always able to keep a nice balance, and that portfolio always matches that client’s risk tolerance; unless it changes. So we have to have to keep up with that, but in essence, it’s it’s on their risk tolerance. So the other description of the bucket methodology uses the same concept with the cash that we do: I agree with that. But here’s the problem with the next concept. So your medium years, you’re going to withdraw from your fixed income accounts. And what would happen then of course, is that let’s say your 60/40 was your mix, right? That’s the mix that matches your risk. Now you’re spending down the 40: You’re starting to spend that down. And all of a sudden, you’re older, and you’re at 80/20: 80% stock, which is outside of your risk tolerance; your personal risk tolerance. And we have a big downturn, you’re 85 years old, and now you’re freaking out, because your portfolio has moved from one risk level to the next.
So, I like the Systematic Withdrawal concept better than the Bucket Methodology. And there may be some modifications to that, that I’m missing. But, at least from what was described in the question, I like the Systematic Withdrawal Methodology better than the Bucket because the key aspect to investing, is to be in a portfolio that matches your risk tolerance. You’re not going to make any money, if the risk of your portfolio is higher than you can tolerate. You’ll make money for a while, and then the market will fall and you’ll freak out, and you’ll sell out at some low point. And so if you’re in the right portfolio, it’ll fall and it’ll be like: “Okay, I knew that was gonna happen. It’s still within my risk tolerance, I feel okay with that”; and you’re gonna hang in there. And that’s the best thing to do, during these downturns, is to be able to kind of hang in there. And so that would be my thing with the Bucket Methodology is just over a period of time, you’re going to have just the last bucket that’s left, it’s going to be stock. So if somebody had a very high risk tolerance that could work, right? That’s fine, for somebody who is… who could easily be… and I have had: I had a 93 year old client that was 100% stock and loved it, and wouldn’t ever buy bonds; that’s just his philosophy. And there’s nothing wrong with that. Everybody’s got their own methodology for risk. But, a vast majority of the people that I run into are much more closer in retirement, especially to kind of that 60/40 mixture; and around that, between 40% stock to 80% stock is the biggest chunk. And so you’re going to be selling off the bond portions at some point and changing the risk of the overall portfolio: That would be problematic in most cases.
Easan Arulanantham:
So essentially, for the Bucket System to work, you’d have to keep rebalancing all of the buckets; to keep the portfolio the same throughout, essentially.
Tom Vaughan:
Which is Systematic Withdrawal: That’s exactly what we do. Yeah, that’s right. I mean, because that’s exactly what we do. When that money market runs down, we rebalance. And so we get… And all of the time, there’s something happening that’s making it get out of balance: The stock market’s outperforming the bond market. All of a sudden, you’re at 70/30 or something, because the bond market went down, stock market went up. And so then, when we’re taking money out and replenishing that money market again, to keep these Systematic Withdrawals going, we rebalance: Back to 60/40. And yeah, that’s exactly right. And what you just described is the Systematic. And so if you keep a fixed set of buckets… I mean I get the concept.
The concept makes sense, because short term money is to be spent sooner. So, cash is shorter term than bonds: You send that first, and then bond is shorter term than stock; and the longer you can let your stock stuff stay in there, man, the more you’re going to make. And so I get it. I mean, that makes sense to me from a term standpoint; but it ignores the risk. And I’m telling you, I’ve been doing this for 35 years, and the number one thing I work on with clients on a regular basis, is making sure that they know the risk. And we even have a company called Riskalyze that we use. They send out an email every quarter showing them, this is what you could lose in the next 2008-type downturn: “Here is how long it would take to come back.” And every quarter, they’re getting an idea of what type of risk they’re taking in their portfolio. Because we have found, over time that, when we get that wrong, those people lose money. They get into they’re in the wrong place, and they lose money: They weren’t in the right risk profile. So, I think that’s a really big piece of it. And I would I would say that trumps the other concept of taking money from shorter term things. The risk tolerance pieces: I’d never ever, ever violate that, ever. It’s the most important component of investor behavior.