It was on my mind a lot lately – what happens when you have saved and invested enough money to reach your FI (financial independence) retirement amount.
Personal finance bloggers seem to only write about how to budget, how to reduce costs and how to invest. They don’t write about what happens when you’ve reached your FI goal. There’s nothing about what to do as you prepare to cross the finish line.
As a perpetual questioner, I embarked on the knowledge finding journey of what happens when you almost have enough money invested for retirement and what happens when you shift from the accumulation phase to the draw down phase.
This article is a journal of a collection of notes as I figured out what to do at the end of the money saving marathon. What I’ve discovered is what suits us and our scenario. What you need for your retirement may be completely different. As always this is not financial advice, but rather the sharing of our journey.
In the beginning
Starting at the beginning: we save and invest around 50% of our income. All of my teacher wages are invested in index funds in the share market with the goal of reaching $1,000,000. From this investment the plan is to retire early by using the safe withdrawal guide of taking 4% from our investment each year. Thus in year one our income will be $40,000. That money is called passive income as it is created from compounding interest, and not from working.
We are well on track to an early retirement, not ridiculously early like the 30 year old personal finance gurus, but more around 55 years. Not bad, considering we didn’t discover investing until our early 40s.
Now you may be thinking that $40,000 doesn’t sound like much money for the year and we admit it is rather a lean budget. However, the freedom from not having to go to work will be worth any short term sacrifices. I say short term, because once we reach 60 years old we will be able to access our superannuation and this will top up our income substantially – whilst having gained an extra five years of a choose your own adventure retirement.
What to do with all that money
We knew how to live on a budget, how to cut costs and how to invest. Yet the next stage was vague.
Here is what I found out (please excuse the amateur drawing):
Our portfolio of index funds in the share market will feed three ‘buckets’. We are keeping in the Barefoot Investor theme here by using buckets aka accounts.
- Dividends: this bucket is where the dividends from the shares will be deposited
- Annual Expenditure: the money needed to cover living expenses for one year
- Cash Cushion: a safety net of savings
How the bucket system works
First thing we needed to do was to confirm a withdrawal rate we were comfortable with. Mr Hack and I revisited the chart below and both agreed that we were still happy with a 4% withdrawal rate.
Having a 4% withdrawal from an investment of $1,000,000 equals $40,000 for the year in living expenses. (The share market returns a higher percentage than 4%. Anything over 4% is left in the investment to allow it to grow to account for inflation.)
On retirement, once a year, the bucket system begins by transferring a year’s worth of dividends from the Dividend Bucket to the Annual Expenditure Bucket.
Now the dividends alone will not equal 4% or $40,000. We needed to calculate $40,000 less dividends to find out how much money we will need to top up to reach that $40,000. This top up comes from selling shares.
But, what if …
No one wants to sell shares in a bear market when the cost per unit has tanked, but if your shares are also the money you need to live off then Plan B is needed.
Plan B: Managing a bear market in retirement
This is where the Cash Cushion will save our ass from being broke pensioners.
If the share market has tanked the process for topping up the dividends is slightly different.
For an annual transfer during a bear market, transfer the money from the Dividend Bucket to the Annual Expenditure Bucket. It’s important to note here that dividends will pay out the same whether it’s a bull market, normal market or bear market and that’s good to know!
Like before, calculate the dividend short fall, but top it up from the Cash Cushion. Then when the market recovers, top up the Cash Cushion by selling some shares from your portfolio.
But, what if there’s an extended bear market …
Research shows that the median length for the stock market to recover from a big crash is around two years.
However, the worst case scenario was the Great Depression which took five years.
This is particularly concerning because the first five years of retirement money from shares are the most fragile. If you sell shares during a down market in the first five years to pay for living expenses, then long term financial health isn’t looking so rosy.
The key to avoiding that scenario is flexibility during an extended bear market. Below are three options that we can use to keep our finances healthy.
Plan C: Live in a LCOL (Low Cost Of Living) area such as Eastern Europe, Mexico or Southeast Asia. This method is known as geoarbritage. By living in a LCOL area we will be able to live off the dividends only and not need a top up.
Plan D: Work on an income producing side hustle
Plan E: Return to work part-time
So, how much money do we need in our Cash Cushion
Another conversation was needed with Mr Hack. We discussed the possibility of a bear market during retirement and the potential time frames. In the end we decided on having a three year Cash Cushion. Enough money to get us through two years of a major share market downturn, plus a year up the sleeve while we take on Plan C, D or E.
It was time to do some more calculating as the Cash Cushion isn’t $40,000 x 3 years, but rather $40,000 less dividends x 3 years.
Annual spending – dividend yield x 3 years = Cash Cushion
It was time to figure out the average dividend yield on our projected portfolio of $1,000,000.
|Share Holding||% of Portfolio||$ Amount||Dividend Yield||Total Dividends|
As you can see from the chart, one year of dividend payouts equals around $27,250.
Using the calculation: annual spending – dividend yield x 3 years = Cash Cushion, we came up with:
Annual spending $40,000 – dividend yield $27,250 = one year of Cash Cushion $12,750 x 3 years = $38,250.
For us to feel comfortable retiring on our shares we would need $38,250 in our Cash Cushion.
At this stage we were starting to feel very excited as a plan was coming into fruition.
The BIG PLAN – trigger points
Our BIG PLAN of trigger points begins with two years to go until retirement.
Two years to go
At this point we will have $900,000 invested in VAS, VEU and IVV. Up until that point we will not have any bonds (VAF) as we are taking the aggressive approach to investing. (Bonds are used to smooth the ride, however they do not have the same capital gains as shares.)
At two years to go we will only buy VAF until we have $100,000 in bonds. Based on projections this will take us 18 months.
12 months to go
With one year until retirement, we will turn off the DRP (dividend reinvestment program) and direct all our dividends into the new Dividend Bucket. This is to prepare for the first annual transfer from the Dividend Bucket to the Annual Expenditure Bucket in 12 months time.
6 months to go
By now we will have $1,000,000 in investments and dividends flowing into the Dividend Bucket. It’s time to start saving into the Cash Cushion Bucket until approximately $38,250 is saved. This will take around six months.
Everything is now set up to RETIRE!
Move the money from the Dividend Bucket to the Annual Expenditure Bucket and top up with:
- Portfolio – in a good market
- Cash Cushion – in a down market
- Plan C, D or E in an extended bear market
- Superannuation – aged 60 and over
That’s right, the icing on the cake, superannuation.
I don’t know about you but I am excited!
What are your plans for managing money post-retirement? Scroll on down and share your money management ideas in the comments box.
Have you heard of the online broker SelfWealth – it’s who we use and I can highly recommend them. Each buy or sell trade only costs $9.50 – no matter how much you are investing. Here’s a link if you’d like to try them out. The link entitles you to 5 free trades (and we get 5 free trades as well). https://secure.selfwealth.com.au/Registration/Plan/5/K2qDn
Disclaimer: I am not a personal finance advisor and this is not financial advice. Do your own research and contact a professional as needed.