Podcast #82 Show Notes: Nearing Retirement

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A listener asked if I could dedicate a podcast to retiring and retirement strategies. She has questions like “do I really think a portfolio 100% in index funds is appropriate for someone retiring? What about some alternative strategies like bond ladders or dividend paying stocks or using options as an insurance policy?”  Now, basically she is asking, “Well, what’s different in your investing life as you approach retirement?” I find this interesting, because this is actually a common misconception that as you near retirement, you need to be doing something dramatically different than a 25 year old or a 35 year old or a 45 year old. But what you need to bear in mind is that a typical 55 year old still has a 30 year investing career ahead of her. The right investments for a 55 year old are exactly the same ones as for a 35 year old. Perhaps the mix of those investments will be a little bit different, but the actual investments are going to be the same.

Before we get into the more detailed answers to her questions I want to say three things.

  1. Thank you for working holidays. I’ve realized, talking to some of my friends that aren’t in medicine, that they’re working really hard right now as we record this, earlier in November so that they basically don’t do anything the last couple weeks of December, which is a little bit surprising to me given the 24/7/365 nature of my work. But thanks for being willing to do that. That’s not an easy thing to do, to be at the hospital, at your work, at the clinic, or on call while other people are enjoying their family and traveling for the holidays and those kinds of things.
  2. I hope you have gotten your flu shot. We already had a young person die in our hospital from the flu within 18 hours of the onset of symptoms, so it sounds like it might be a nasty year like that one a few years ago where we had all those young people, and particularly pregnant women, dying from the flu.
  3. Let’s try to keep the drama to a minimum in the WCI Facebook group and focus on helping each other with our finances rather than the political issues of the day or turf wars in medicine. We had a kerfluffle recently in the Facebook group and it was interesting just how much drama it generated. It’s not necessarily a bad thing. I guess if I’m in the publicity business, there’s no such thing as bad publicity and we actually had a lot of new members come into the group because of it, but sadly we had a few people leave. The drama was just a little bit too much.

Now on to the regularly scheduled program…

Podcast #82 Sponsor

lower s corp taxes

This episode is sponsored by Alexis Gallati of Gallati Professional Services – Alexis is not your typical tax advisor. With over 15 years of experience, she has been helping physicians all over the country save money on their taxes. As the spouse of a busy physician, she understands the burden of high tax payments physicians incur during their lifetime. Not only will she create a high level strategic tax plan for you, guaranteeing money in your pocket, but Alexis will proactively work with you throughout the year to maintain your tax plan, prepare your annual tax returns, and represent you in case of an audit. The investment in her tax planning services is a fixed-price agreement and her tax maintenance packages are a flat monthly fee. If you’re tired of complex tax jargon and giving away most of your paycheck to the IRS, visit Alexis’ website at www.GallatiTax.com today to schedule your free initial consultation.

Quote of the Day

Our quote of the day today comes from Caterina Fake. She said,

“The most successful entrepreneurs I know are optimistic. It’s part of the job description.”

I think that is pretty true. If you’re not optimistic about the future, you’re probably not going to put in the time and money required to start a new business.

Investing When Nearing Retirement

What is different in your investing life as you approach retirement? You don’t need to be doing something dramatically different than a 25 year old. The right investments for a 55 year old are exactly the same ones as for a 25 year old. The mix of those investments will be a little bit different, but the actual investments are going to be the same.

My portfolio is 85% index funds and there is absolutely nothing wrong with having a portfolio that is 100% index funds, but the problem is, a lot of people think of an index fund and they have this image in their mind of an S&P 500 index fund and that is it. Obviously an S&P index fund is not only 100% stock, but it’s 100% large cap US stocks, not a terribly diversified portfolio. It’s better than having all your money in Apple and GE, I suppose, but still, compared to a portfolio where you incorporate some international stocks and some smaller stocks and maybe some value stocks and some real estate and some bonds, it is just not very diversified. But the truth of the matter is, you can have an index fund of all those things. So it is completely appropriate to have a portfolio that’s 100% index funds. Whether you’re 35 or whether you’re 75.

Sequence of Returns Risk

The main difference as you approach retirement age is that your sequence of returns risk goes up. Sequence of returns risk is that risk that even though your average investment return is adequate to support you in retirement, the sequence of those returns is bad. Basically that means when your portfolio is big, those last few years before retirement and the first few years after retirement, if you have the poor returns then, then there is more risk of running out of money. Basically you’re taking money out as your investments perform poorly and that is what sets you up for risk of running out of money. What a lot of people do around those time periods as they get close to the retirement date and for at least the first few years after retirement, is have a little bit less risky portfolio. But it is not a different portfolio, it is just a more conservative mix of investments. Instead of being 70% stock, for instance, maybe you’re 55% stock. You are just taking a little bit less risk in case those bad returns show up and give you a bad sequence of returns.

Income Focus

Maybe it is also appropriate, as you start living off your investments, to have a slightly bigger income focus from the investments than you had during your working years. For example, I’ve got plenty of income coming in from my job as a physician and from my work at The White Coat Investor. I don’t need extra income from my investments. If you compare a couple of different real estate funds that I’m invested in, one has not called in all my capital. They are still finding new properties to invest in and literally have not paid me a bit of income in the last year and a half, but that’s just fine, I don’t need the income now. On the other hand, some of my hard money loan funds pay out every month and unfortunately I’m having to pay taxes on it. But if I was in retirement, I’d probably be a little more likely to appreciate the income coming from the hard money loan fund than I would the other fund, just because I’m actually trying to live on that income now. So I think it is okay to have a little bit more of a focus on income in retirement than you had during the accumulation phase.

Bond Ladder

One listener asked specifically about a bond ladder. A bond ladder is where you basically buy a bond that pays out a certain amount each year and that is the amount you live on. For example, if you’re going to ladder the next 10 years, you would buy a ten year bond, a nine year bond, an eight year bond, a seven year bond, a six year bond, and as those bonds mature, you would live off the proceeds for that year. The nice thing about it is you basically locked that in. All you have to do is hold onto that and the bond is going to give you that principle back along with some interest in that year that you need it. It is a pretty conservative way to invest.

Bear in mind that this is really only appropriately done with treasury bonds. You don’t want to be doing this with a GE bond or an Enron bond. You just don’t want to take that sort of risk if you’re going to buy individual stocks. If you’re going to use corporate or municipal bonds, you probably want to be in a fund so you’re getting diversification. With the federal government, maybe you don’t need that quite as much. The types of ladders I typically see people using, however, are TIPS ladders, Treasury Inflation Protected Securities. So not only are you having that payout guaranteed in a certain number of years, but you’re also having that payout be indexed to inflation in case there is some unexpected inflation between now and when you need the money.

I think those are all reasonable things to do during retirement. It is a little bit more of a hassle though, honestly. You want to keep it simple? Just put it in a bond index fund.  I don’t expect to use a bond ladder but if you want to use it, there is nothing unreasonable about doing that with part of your portfolio.

Dividend Stocks

The listener asked about dividend paying stocks. I’m not sure what the fascination there is. It is really not dramatically different whether a company pays you a dividend or whether the share price goes up in value and you sell some shares and basically declare your own dividend. In fact, it is a lot more tax efficient if you can just do that, because not only are you getting long term capital gain tax rates on those self-proclaimed dividends, but you get to control when they come. And so I think there is a lot of benefit to that.

There is this idea that somehow a dividend paying stock is magical and that the dividends never go down but in the first six months of the 2008 crisis, over 100 stocks in the S&P 500 cut their dividend. These things do get cut and dividend stocks do go to zero all the time. There is nothing magical about a company that has paid a dividend for many years. What you do get, if you tilt your portfolio a little bit toward dividend paying stocks, though, is you give yourself a value tilt and that is fine. The long term data suggests if you tilt your portfolio toward value stocks, you’ll have a little bit higher return over the long run. But bear in mind that requires that the future resemble the past. We don’t know that is necessarily the case. We really only have good data for stocks over the last 100 years and some data over maybe another 100 years and that is it. It is limited data.  If you believe that value stocks are going to outperform, I think it’s fine to tilt your portfolio toward value stocks. If you want to do that using a dividend paying stock index fund of some kind, that’s okay to do that. But bear in mind that data suggests that is not the best way to get a value tilt. You are actually better off if it determines that tilt by a price to book ratio rather than how much dividend is paid out. I don’t think there is anything necessarily magic about a dividend paying stock and I think a lot of people can make some significant investment mistakes if they get overly focused on dividends.

Options as an Insurance Policy

Options as an insurance policy was another question she had. The idea here is that you would use an option such that if your investments tank dramatically, you could use the option to somehow protect yourself from that drop. And there are ways to do that. The problem is options have a negative expected return. Like any insurance policy, it’s going to cost you something to have it. I think it’s probably not an insurance policy that you need. As I mentioned at the beginning, when you are investing in retirement, you’re going to be investing for 30 years or more from the point of retirement. It’s not like you need all the money tomorrow. And so you can write out a downturn or two or three or four or five like you probably will during a period of retirement.

So how do you do that before retirement? You do it with a mix of assets. Stocks and bonds and real estate. You ride the waves up. You ride the waves down. It is fine. That doesn’t change just because you retired. So I don’t know that I would necessarily incorporate some complex options strategy as I near retirement. I wrote a blog post called Common Questions About Investing in Retirement  that you might find helpful if you have more questions about investing in retirement.

Safe Withdrawal Rate

One question that I get a lot is about a safe withdrawal rate in retirement. Is 25 times what you spend enough or do you need 40 times? The general number rule of thumb is the 4% rule and that means you need about 25 times what you spend in order to have enough to retire.

You get these pessimists banding together and they bounce off each other in their echo chamber and before you know it, people are taking out 1% of their portfolio a year, which is absolutely stupid. It is going to be somewhere around 4% and probably higher. You just don’t know it and the reason why you probably ought to start a little lower, around 4%, is just in case you do have a bad sequence of returns early in retirement.

The truth of the matter is that you ought to adjust as you go. Just because you start at 4%, doesn’t mean you’re locked into that. If you get four or five terrible years of investment returns as soon as you retire, you probably ought to be cutting back a little bit and adjusting as you go. People seem to think that this is the end of the world. It’s not the end of the world. You did this the entire way though your working career. You adjusted your spending according to what you had and what you were making and there’s no reason you can’t continue to do that in retirement.

Optimal Withdrawal Strategy

Where should you take your money from first in retirement?

  1. If you are 70 and a half you have to take out your required minimum distributions from your tax deferred accounts. That ought to be the first thing you take out, because you’re required to take it out. The last thing you want to do is leave that money in there, because the penalty is bad, 50% of what you should have taken out. There is no way you want to forget to do your required minimum distributions.
  2. The next thing you ought to spend in retirement is all the stuff that has to come out and has to be taxed. What am I talking about here? I’m talking about dividends from your taxable account, stocks or mutual funds, capital gains distributions, your rental income, anything else you may have that is coming in that is going to be taxed anyway. You might as well spend that next.
  3. Following that is all of your guaranteed payments. Things like social security, some pensions if you may have them. If you purchased an annuity that is making payments you might as well spend that next.
  4. Following that, I would reach next for your 457 money, if you have a 457 account, and the reason why is that money is actually not yours. It’s still your employer’s, so it is subject to the creditors of your employer and if your employer goes under, you could lose that money. So it probably ought to be spent preferentially before any money in your retirement account, money that is actually yours by law.
  5. Next reach for your taxable assets with a high basis. Now, what does that mean? That means assets that are worth about what you paid for them. So this is stuff that you can sell and spend the money without having to pay significant capital gains taxes. You should always sell something that has a loss and tax lost harvest it, but I’m talking about stuff where it’s just not going to cost you very much in taxes to sell it.

After those five it gets little complicated and you have a few options. You can take your taxable assets with a low basis out or you can take additional money out of your tax deferred accounts or you can take tax free withdrawals from your Roth IRA. Now, obviously your heirs would love it if you leave them a Roth IRA, but sometimes it makes sense for you to withdraw from your Roth IRA and spend that. The general rule is you take from your taxable assets, which would be things that are going to generate more taxes and your tax deferred accounts up to the top of the next bracket. For example, if you’re in the 22% bracket, you take out enough that it gets you up to the top of that and then beyond that, you take from your tax free or Roth accounts. That basically allows you to set your effective tax rate on withdrawal of those assets. If you need more, you take them from Roth. If you don’t need that much, you don’t even take all of that out. It is nice to have a mix. Most of us will have a mix of some type and it is nice to have that ability, that tax diversification, to be able to determine how much you take out.

Sometimes people kind of get suckered into buying a whole life insurance policy and wonder, “Well, when do I tap that?” And I think the truth of the matter is that’s probably best tapped relatively late in retirement, if at all. It is a life insurance policy. It works great for an inheritance. If you want to leave that to your heirs, they’ll inherit it tax free. And so there is nothing wrong with just leaving that for your heirs if you don’t need the money, but if you do need money, then you can use that.

Another asset that some people tap when they’re really short on cash in retirement is a reverse mortgage. They basically get at the home equity. I would be a little bit careful about that, because there are not great terms sometimes on these reverse mortgages. If you don’t need to tap it, maybe you shouldn’t, but it certainly is a source of funds for a lot of retirees. You can get at your home equity just by selling the place and downsizing. That is an option. Other people take out more of a traditional mortgage, but I think a reverse mortgage can also make sense in some scenarios there. But you’ll notice that both the cash value life insurance and the reverse mortgage come in at the end of the list.

Annuities

Another question people have about investing for retirement as they move closer to retiring is should you get an annuity? When I’m talking about annuity, I’m not talking about what the brokers sell with these terrible high commissions and crummy terms. I’m talking about a single premium, immediate annuity that’s paying out better than any others for your age. Should you get one of these? If you don’t have a pension, if you’re not getting a lot in social security, sometimes it can make sense to have some guaranteed income in retirement. Basically what a single premium immediate annuity or a SPIA is, is a pension. You’re buying a pension from an insurance company.

You give them a lump sum of money and then they immediately start paying you out a guaranteed amount every month from now until the day you die and that provides some longevity insurance for you. If you live a long time, you’ve got that money sitting there and you know it is going to keep coming in and that allows you to take a little bit more risk with your investments. It allows you to worry about money a little bit less. Now, is the return on it awesome? No. If you’re trying to maximize the amount of money you have left and you’ll leave to your heirs, you’re probably better off keeping that money invested in aggressive investments like stocks and real estate and that sort of stuff. But if you’re looking for some guarantees, a single premium immediate annuity is probably the first place you ought to be looking at.

Cash Reserve

Another frequent question, how much cash reserves should I keep in case of a down market?  I think this really depends on the person. For example, if you have lots of guaranteed income and you’re basically living completely off guaranteed income like social security and a pension and an immediate annuity, then I don’t think you need that much in cash at all. If you’re mostly living off selling some of your risky assets like stocks in retirement, then I think you need a substantial amount of cash. Enough to ride out a market downturn anyway. So I’d say two to three years worth of spending in cash would not be unreasonable in that sort of a situation, but everybody is going to be different. I think you probably ought to have some on hand that will keep you from having to sell assets low.

Asset Allocation

What should my stock to bond ratio be in retirement? There is no perfect answer to that question, but there is a few considerations. One, if you’ve got more than enough, bear in mind that the game of investing is trying to reach your financial goals while taking as little risk as possible. So once you’ve won the game, stop playing. That is one school of thought. The other school of thought is, well, the more you have, the more risk you can afford to take and the more you can leave to heirs or to charity so some people actually take on more risk as they become wealthier.

It is critical that you don’t exceed your risk tolerance, though. The worst thing you can do, either nearing retirement or in retirement, is selling low. If a 2008 kind of market scenario happens you lose a bunch of money and all of a sudden you lock in those losses by selling low. That is a financial catastrophe. You really want to avoid doing that. You want to get as close to your risk tolerance as possible without exceeding it and that would be a little bit easier if our risk tolerance were stable. The issue is most of us feel like we can tolerate a lot of risk when markets are going up and then all of a sudden when markets start going down, we don’t tolerate nearly as much as we think. I would encourage you to err on the conservative side.

Hopefully by the time you are approaching retirement you have a pretty good idea what your risk tolerance is and what stock to bond ratio you can tolerate in a market downturn. A lot of investors discover that their risk tolerance gets better over the years. They are supposed to be having this decreasing stock to bond ratio as they get closer to retirement due to sequence of returns risk, but instead, they’re actually able to tolerate more risk because they’ve learned to do so. They’ve just become used to the market fluctuations. That may be you.

Q&A from Readers and Listeners

Retirement Plans for Employees

A dentist is looking into offering a 401K for his five employees and himself, but based on the employees, it would be extremely expensive to make it worthwhile. The alternative would be to offer a simple IRA, but then he wouldn’t be able to do the back door Roth IRA anymore, plus it would only allow him to put in $12,500 for himself and $12,500 for his wife so maybe he shouldn’t offer a retirement plan at all?

The truth is, once you have employees for your practice, a retirement plan is no longer a do it yourself project. If it is just you as an independent contractor, go get yourself an individual 401K. But if you have employees, you can’t do that. So you really need to get an expert in there to look at your practice, look at the ages of your employees , how much they’re likely to save, and how much you want to save. Do a study of it and decide what is right for you. Sometimes that might be a simple IRA. Sometimes it might be a SEP-IRA. If the option is one of those choices, you’re not going to be able to do a back door Roth IRA.

Maybe it makes sense to have a 401K of some type and then sometimes it might not make sense to offer anything to your employees. You have to really dive into the weeds here and have this discussion with a professional and your employees and decide where to go. Certainly you can save for retirement in a taxable account yourself. Between your taxable account and your back door Roth IRAs, maybe that is all you do and that is okay. You can certainly save enough in those.

Financial Literacy from the ACGME

“I’ve always been a little surprised by the idea that residents and fellows should learn financial literacy from the ACGME or through some aspect of their training programs. After all, I didn’t expect the attendings in my residency to teach me how to prepare healthy meals or to lead exercise classes at the end of the day, which is arguably more important than financial wellness. Clearly the WCI content is so much better than anything the ACGME provides on financial literacy. Let the ACGME in residency just simply distribute your book or at least a link to your website rather than trying to teach residents about everything under the sun. That said, props to the scattered academic docs out there talking to their residents and giving them the basics of financial literacy.”

That would be awesome if the ACGME just handed out my book to all residents! But you spend so much time in training between medical school, residency, and fellowship. What is a couple of hours here and there of financial literacy? I don’t think we are asking too much to have a little bit of that in medical school and a little bit of that in residency. Obviously this is never going to take the place of your primary specialty training, but it wouldn’t be that hard to, once a year, give a few hours of financial information. I think there is plenty of room in the curriculum for that.

Ending

If you spend any time on Reddit at all, be sure to check out The White Coat Investor sub Reddit. It is not as active as I’d like it to be and it sure would be nice if we could get a core group of people there like we have on the forum and the Facebook group. There are a lot of people on Reddit and I think the WCI message isn’t getting to them as well as I’d like. So if you like Reddit, please stop by The White Coat Investment sub Reddit once a week or so, answer some questions from people and let’s see if we can build a community there as well.

Full Transcription

This is the White Coat Investor podcast, where we help those who wear the white coat get a fair shake on Wall Street. We’ve been helping doctors and other high income professionals stop doing dumb things with their money since 2011. Here’s your host, Dr. Jim Dahle.

Welcome to White Coat Investor, podcast number 82: Nearing Retirement. Today on the podcast, we’re going to talk about those issues you face as you get close to retirement age. But first, a word from our sponsor.

This episode is sponsored by Alexis Gallati of Gallati Professional Services. Alexis is not your typical tax advisor. With over 15 years of experience, she has been helping physicians all over the country save money on their taxes. As the spouse of a busy physician, she understands the burden of high tax payments physicians incur during their lifetime. Not only will she create a high level, strategic tax plan for your, guaranteeing money in your pocket, but Alexis will proactively work with you throughout the year to maintain your tax plan, prepare your annual tax returns and represent you in case of an audit. The investment in her tax planning services is a fixed price agreement and her tax maintenance packages are a flat monthly fee. If you’re tired of complex tax jargon and giving away most of your paycheck to the IRS, visit Alexis’ website at www.gallotitax.com. That’s G-a-l-l-a-t-i tax.com today to schedule your free initial consultation.

I hope you’re all ready for the holidays. Thanks for being willing to work during the holidays, by the way. I’ve realized, talking to some of my friends that aren’t in medicine, that they’re working really hard right now as we record this, earlier in November so that they basically don’t do anything the last couple weeks of December, which is a little bit surprising to me given the 24/7/365 nature of my work. But thanks for being willing to do that. That’s not an easy thing to do, to be at the hospital, at your work, at the clinic, on call, whatever, while other people are enjoying their family and traveling for the holidays and those kinds of things.

I also hope you’ve gotten your flu shot. We already had a young person die in our hospital from the flu within 18 hours of the onset of symptoms, so it sounds like it might be kind of a nasty year like that one a few years ago where we had all those young people, and particularly pregnant women, dying from the flu.

We had a kerfluffle recently in the Facebook group and, you know, Facebook is always going to Facebook, but it was interesting just how much drama it generated. It’s not necessarily a bad thing. I guess if I’m in the publicity business, there’s no such thing as bad publicity and we actually had a lot of new members come into the group because of it, but sadly we had a few people leave. The drama was just a little bit too much. So let’s try to keep the drama to a minimum in the Facebook group and on the forum and on the sub Reddit and focus on helping each other with our finances rather than the political issues of the day or turf wars in medicine, et cetera.

I actually really like forums and books. Those are kind of my preferred ways of learning about financial information. I participated on forums for years and years and years and actually the reasoning behind why I started the White Coat Investor blog was so I didn’t have to keep typing the same thing into forums over and over again. My idea was just to be able to post a link in response to a common question from doctors. Obviously this is all kind of weird given the success of the blog and now the podcast. Obviously there’s lots of people that feel differently than I do. The wonderful thing about books, of course, is that most of what you need to know about investing isn’t changing day to day. And so even a book published 10 years ago contains lots of useful information. But that’s just kind of my medium. Whatever your preferred medium is, whether it’s social media or podcasts, which it probably is, given you’re listening to this.
We’re trying to get you this information you need to be financially literate and make good financial decisions in that preferred format.

Our quote of the day today comes from Caterina Fake. She said, “The most successful entrepreneurs I know are optimistic. It’s part of the job description.” And I think that’s pretty true. If you’re not optimistic about the future, you’re probably not going to put in the time and money required to start a new business.

Let’s start our podcast today with a Speak Pipe question. I hope those of you who are starting to hear these and would be interested in having your question answered in the White Coat Investor podcast will go onto the website, go onto the tab of WCI Plus and there you’ll see the podcast page and you can click on that. There’s a link that you can go to and just record right from your computer your question and we’ll put it into the podcast. But here’s our first question. This one comes in from one of our listeners.

I wonder if you could dedicate a podcast to retiring and retirement strategies. Do you really think a portfolio 100% in index funds is appropriate for someone retiring? What about some alternative strategies like bond ladders or dividend paying stocks or using options as an insurance policy? Just some of the questions I have as I approach retirement.
Now, basically here she’s asking, “Well, what’s different in your investing life as you approach retirement?” You know, she wonders, well, is a portfolio in 100% index funds appropriate? What about some of these other strategies you could be using like bond ladders and dividend paying stocks and using options as an insurance policy. I find this interesting, because this is actually a common misconception that as you near retirement, you need to be doing something dramatically different than a 25 year old or a 35 year old or a 45 year old. But what you need to bear in mind is that a typical 55 year old still has a 30 year investing career ahead of her. The right investments for a 55 year old are exactly the same ones as for a 35 year old. I mean, perhaps the mix of those investments will be a little bit different, but the actual investments are going to be the same.

You know, my portfolio is 85% index funds and there’s absolutely nothing wrong with having a portfolio that’s 100% index funds, but the problem is, a lot of people think of an index fund and they have this image in their mind of an S&P 500 index fund and that’s it. That’s what an index fund is to them. Obviously an S&P index fund is not only 100% stock, but it’s 100% large cap US stocks and it’s not a terribly diversified portfolio. It’s better than having all your money in Apple and GE, I suppose, but still, compared to a portfolio where you incorporate some international stocks and some smaller stocks and maybe some value stocks and some real estate and some bonds, it’s just not very diversified. But the truth of the matter is, you can have an index fund of all those things. You can have a bond index fund. You can have an international stock index fund. You can have a small value index fund. You can have a real estate investment trust index fund.

So yes, it’s completely appropriate to have a portfolio that’s 100% index funds. I mean, what’s the alternative? You want to run the undiversified risk of picking your own stocks? You want to try to find a mutual fund manager that’s going to pick funds well for you? I mean, I don’t think those are … Or that’s going to pick stocks well for you? I mean, I think the likelihood of doing that is so low it’s not worth trying to do. So absolutely would not necessarily be against a 100% index fund portfolio for anyone. Whether you’re 35 or whether you’re 75.

The main difference as you approach retirement age is that your sequence of returns risk goes up. Sequence of returns risk is that risk that even though your average investment return is adequate to support you in retirement, the sequence of those returns is bad. Basically that means when your portfolio is big, those last few years before retirement and the first few years after retirement, if you have the poor returns then, then there’s more risk of running out of money. Basically you’re taking money out as your investments perform poorly and that is what sets you up for risk of running out of money. And so what a lot of people do around those time periods is they get close to the retirement date and for at least the first few years after retirement, they have a little bit less risky portfolio. But it’s not a different portfolio, it’s just a more conservative mix of investments. Instead of being 70% stock, for instance, maybe you’re 55% stock. You’re just taking a little bit less risk in case that those bad returns show up and give you a bad sequence of returns.

Maybe it’s also appropriate, as you start living off your investments, to have a slightly bigger income focus from the investments than you had during your working years. For example, I’ve got plenty of income coming in from my job as a physician and from my work at The White Coat Investor. I don’t need extra income from my investments. In fact, I’d rather not have extra income from my investments, because it all gets taxed at a very high rate, unless it qualifies for long term capital gains rates or qualified dividend rates, or if I can shelter it, maybe, with some of the real estate depreciation, that sort of a thing. But for the most part, I don’t need income right now.

If you compare a couple of different real estate funds that I’m invested in, one is the Origin Fund and I think I’ve been funding this for about a year and a half. They still haven’t called all my capital. They’re still finding new properties to invest in and literally haven’t paid me a bit of income in the last year and a half, but that’s just fine. I mean, this is a planned seven to ten year investment and I don’t need the income now. I don’t want the income now and I never expected to have the income now. On the other hand, some of my hard money loan funds pay out every month, I mean, 10%, 12% I’m getting that income and unfortunately I’m having to pay taxes on it. But if I was into retirement, I’d probably be a little more likely to appreciate the income coming from the hard money loan fund than I would the origin fund, just because I’m actually trying to live on that income now and so I think it’s okay to have a little bit more of a focus on income and retirement than you had maybe during the accumulation phase.

The caller also asked about some other things specifically. For example, a bond ladder. Now, what a bond ladder is, is you basically buy a bond that pays out a certain amount each year and that’s the amount you life on. For example, if you’re going to ladder the next 10 years, what you would buy is you would buy a 10 year bond, a nine year bond, an eight year bond, a seven year bond, a six year bond, and anyway, as those bonds mature, you would live off the proceeds for that year. So that’s an idea that a lot of people have put forward and the nice thing about it is you basically locked that in. All you have to do is hold onto that and the bond is going to give you that principle back along with some interest in that year that you need it. You know, it’s a pretty conservative way to invest.

Bear in mind that this is really only appropriately done with treasury bonds. You don’t want to be doing this with a GE bond or an Enron bond, you know? You just don’t want to take that sort of risk if you’re going to buy individual stocks. If you’re going to use corporates and maybe even municipal bonds, you probably want to be in a fund so you’re getting diversification there. With the federal government, maybe you don’t need that quite as much.

The types of ladders I typically see people using, however, are TIPS ladders. Treasure, inflation, protected securities. So not only are you having that payout guaranteed in a certain number of years, but you’re also having that payout be indexed to inflation in case there’s some unexpected inflation between now and when you need the money. So I think those are all reasonable things to do during retirement. It’s a little bit more of a hassle though, honestly. You know, you want to keep it simple? Just put it in a bond index fund. It’s fine. I don’t know that I expect to use a bond ladder. My parents aren’t using a bond ladder, but if you want to use it, there’s nothing unreasonable about doing that with part of your portfolio.

Dividend paying stocks are an interesting thing, though. I’m not sure what the fascination here is. Dividends are great, right? Something paid out from the company, but it’s really not dramatically different whether a company pays you a dividend or whether the share price goes up in value and you sell some shares and basically declare your own dividend. In fact, it’s a lot more tax efficient if you can just do that, because not only are you getting long term capital gain tax rates on those self-proclaimed dividends, but you get to control when they come. And so I think there’s a lot of benefit to that. There’s this idea that somehow a dividend paying stock is somehow magical and that the dividends never go down.

Well, in the first six months of the 2008 crisis, over 100 stocks in the S&P 500 cut their dividend. These things do get cut and dividend stocks do go to zero all the time. I mean, if you haven’t watched a company that used to be a blue chip company like Sears, you know, maybe is one of the more recent ones, go to be worth basically nothing, you just haven’t been investing long enough. There is nothing magical about a company that’s paid a dividend for many years. What you do get, if you tilt your portfolio a little bit toward dividend paying stocks, though, is you give yourself a value tilt and that’s fine. The long term data suggests if you tilt your portfolio toward value stocks, you’ll have a little bit higher return over the long run. But bear in mind that that requires that the future resemble the past. We don’t know that that’s necessarily the case. We really only have good data for stocks over the last 100 years and some data over maybe another 100 years and that’s it. It’s limited data. This isn’t physics. It’s investing.

If you believe that value stocks are going to outperform, I think it’s fine to tilt your portfolio toward value stocks. If you want to do that using a dividend paying stock index fund of some kind, that’s okay to do that too. But bear in mind that data suggests that is not the best way to get a value tilt. You’re actually better off if it determines that tilt by a price to book ratio rather than how much a dividend is paid out. I don’t think there’s anything necessarily magic about a dividend paying stock and I think a lot of people can make some significant investment mistakes if they get overly focused on dividends.

For example, maybe you have a stock that pays out an 8% or 10% dividend and that sound awesome, right? Until you realize it’s going down in value by 5% or 6% every year and then you realize, well, you’re really getting your principle and calling it a dividend. So you want to be careful of those sorts of situations. There’s a reason some stocks are paying high dividends and it’s because they’re falling rapidly in value.

Options as an insurance policy was another question she had and the idea here is that you would use an option such that if your investments tank dramatically, you could use the option to somehow protect yourself from that drop. And there are ways to do that. The problem is options have a negative expected return. Like any insurance policy, it’s going to cost you something to have it. I think it’s probably not an insurance policy that you need. As I mentioned at the beginning, when you are investing in retirement, you’re going to be investing for 30 years or more from the point of retirement. It’s not like you need all the money tomorrow. And so you can write out a downturn or two or three or four or five like you probably will during a period of retirement.

So how do you do that before retirement? Well, you do it with a mix of assets. Stocks and bonds and real estate. You ride the waves up. You ride the waves down. It’s fine. That doesn’t change just because you get retired. So I don’t know that I would necessarily incorporate some complex options strategy as I near retirement. I think it’s probably something that’s best avoided.

I wrote a blog post. It was the first post of 2017, actually, but I called it Common Questions About Investing in Retirement. There’s actually a lot of these questions that come out that I get by email, but I don’t talk about them a lot and part of that is because a lot of my audience is younger. I’ve got a lot of medical students and residents and young attendings and I’m trying to get them on the right path, for sure. So it’s definitely a smaller part of my readership that’s retired, but these are important questions to address, because all of us are going to get there eventually.

For example, one question that I get a lot is 25 times what you spend enough or do you need 40 times? Well, this comes down to what a safe withdrawal rate is and I think it’s worth looking at the studies that suggest what a safe retirement withdrawal rate is going to be. The general number, the general rule of thumb here is the 4% rule and if you reverse engineer that, you can see if you can take 4% of your portfolio out a year safely and expect your money to last throughout retirement, you know, increasing that amount with inflation each year and that means you need about 25 times what you spend in order to have enough to retire. So that works most of the time. Now, there are a tiny percentage of time, 3%, 5%, maybe something like that, when that doesn’t work and so because people worry about that, those small percentage of time periods, they say, “Well, you need more. You need 33x or you need 40x what you’re spending,* and at a certain point, it just gets kind of ridiculous.

You get these pessimists banding together and they bounce off each other in their echo chamber and before you know it, people are taking out 1% of their portfolio a year, which is absolutely stupid. I mean, the truth of the matter is, it’s going to be somewhere around 4% and probably higher is what a safe withdrawal rate will be for you. You just don’t know it and the reason why you probably ought to start a little lower, around 4%, is just in case you do have a bad sequence of returns early in retirement.
But here’s the truth of the matter. The truth of the matter is that you ought to adjust as you go. Just because you start at 4%, doesn’t mean you’re locked into that. If you get four or five terrible years of investment returns as soon as you retire, you probably ought to be cutting back a little bit and adjusting as you go. People seem to think that this is the end of the world. It’s not the end of the world. You did this the entire way though your working career. You adjusted your spending according to what you had and what you were making and there’s no reason you can’t continue to do that in retirement.

All right. Another common question I get is for a doc who has a Roth account and maybe a tax deferred account like a 401K, maybe a 457 and a taxable brokerage account. What’s the optimal withdrawal strategy? Where should you take your money from first? And I think this is a little bit easier than maybe that last question, but it can still be a complicated situation. For example, one thing you have to do once you’re 70 and a half is you have to take out your required minimum distributions from your tax deferred accounts. That ought to be the first thing you take out, because you’re required to take it out. The last thing you want to do is leave that money in there, because the penalty is bad. It’s 50% of what you should have taken out, so there’s no way you want to forget to do your required minimum distributions. I mean, if your financial advisor forgets to do this, I mean, that’s like as bad a financial malpractice as there is. They just cost you half of your required minimum distribution that year.

The next thing you ought to spend in retirement is all the stuff that has to come out and has to be taxed. What am I talking about here? I’m talking about dividends from your taxable account, stocks or mutual funds, capital gains distributions, your rental income, anything else you may have that’s coming in that’s going to be taxed anyway. You might as well spend that next. Following that is all of your guaranteed payments. Things like social security, some pensions if you may have them. If you purchased an annuity that’s making payments, all that kind of stuff that has to come out again, you might as well spend that next.

Following that, I would reach next for your 457 money, if you have a 457 account, and the reason why is that money is actually not yours. It’s still your employer’s, so it’s subject to the creditors of your employer and if your employer goes under, you could lose that money. So it probably ought to be spent preferentially before any money in your Roth IRAs or in your taxable accounts or in your 401K’s et cetera. Money that’s actually yours by law.

Next, I think you should reach for your taxable assets with a high basis. Now, what does that mean? That means assets that are worth about what you paid for them. So this is stuff that you can sell and spend the money without having to pay significant capital gains taxes. You should always sell something that has a loss and tax lost harvest it, but I’m talking about stuff where it’s just not going to cost you very much in taxes to sell it.

Then after this point, it gets kind of complicated and you’ve got a few options here. You can take your taxable assets with a low basis out or you can take additional money out of your tax deferred accounts or you can take tax free withdrawals from your Roth IRA. Now, obviously your heirs would love it if you leave them a Roth IRA, but sometimes it makes sense for you to withdraw from your Roth IRA and spend that. The general rule is you take from your taxable assets, which would be things that are going to generate more taxes and your tax deferred accounts up to the top of the next bracket. For example, if you’re in the 22% bracket, you take out enough that it gets you up to the top of that and then beyond that, you take from your tax free or Roth accounts. That basically allows you to set your effective tax rate on withdrawal of those assets. If you need more, you take them from Roth. If you don’t need that much, you don’t even take all of that out. And so I think those are some good tips for how to deal with those accounts in retirement.

It’s nice to have a mix. Most of us will have a mix of some type and it’s nice to have that ability, that tax diversification to be able to determine how much you take out. Now, some other assets that people sometimes have. Sometimes people kind of get suckered into buying a whole life insurance policy and wonder, “Well, when do I tap that?” And I think the truth of the matter is that’s probably best tapped relatively late in retirement, if at all. I mean, it’s a life insurance policy. It works great for an inheritance. If you want to leave that to your heirs, they’ll inherit it tax free. And so there’s nothing wrong with just leaving that for your heirs if you don’t need the money, but if you do need money, then you can go after that and even if you have to pay interest on borrowing against it, that can still make some sense if you have one of those assets that you ended up buying.

Another asset that some people tap when they’re really short on cash in retirement is a reverse mortgage. They basically get at the home equity. Now, I’d be a little bit careful about that, because it’s not that great of a term sometimes on these reverse mortgages. So I think if you don’t need to tap it, maybe you shouldn’t, but it certainly is a source of funds for a lot of retirees. You can get at your home equity just by selling the place and downsizing. That’s an option. Other people take out more of a traditional mortgage, but I think a reverse mortgage can also make sense in some scenarios there. But you’ll notice that both the cash value life insurance and the reverse mortgage come in at the end of the list.

Another question people have about investing in retirement as they’re moving into retirement is should you get an annuity? When I’m talking about annuity, I’m not talking about the crap that the brokers sell with these terrible high commissions and crummy terms. I’m talking about a single premium, immediate annuity that’s paying out better than any others for your age. And so the question is, should you get one of these? Well, if you don’t have a pension, if you’re not getting a lot in social security, sometimes it can make sense to have some guaranteed income in retirement. Basically what a single premium immediate annuity or a SPIA is, is a pension. You’re buying a pension from an insurance company.

You give them a lump sum of money and then they immediately start paying you out a guaranteed amount every month from now until the day you die and that provides some longevity insurance for you. If you live a long time, you’ve got that money sitting there and you know it’s going to keep coming in and that allows you to take a little bit more risk with your investments. It allows you to worry about money a little bit less. Now, is the return on it awesome? No. If you’re trying to maximize the amount of money you have left and you’ll leave to your heirs, you’re probably better off keeping that money invested in aggressive investments like stocks and real estate and that sort of stuff. But if you’re looking for some guarantees, a single premium immediate annuity is probably the first place you ought to be looking at.

Okay. Here’s another question. Should you be looking at the market conditions and change your withdrawal locations based on that? Well, sure. I mean, if you have a crystal ball, you know what the market is going to do in the future, then you want to take from your tax free accounts at market peaks and from your tax deferred accounts, at market troughs. And your taxable accounts at market troughs as well. But the problem is, none of us have a working crystal ball and so I think you’re much better off focusing what you’re taking out from each account on filling it up to the next bracket and then taking tax free withdrawals above that.

Another frequent question, how much cash reserves should I keep in case of a down market? And I think this really depends on the person. For example, if you have lots of guaranteed income and you’re basically living completely off guaranteed income like social security and a pension and an immediate annuity, then I don’t think you need that much in cash at all. If you’re mostly living off selling some of your risky assets like stocks in retirement, then I think you need a substantial amount of cash. Enough to ride out a market downturn anyway. So I’d say two to three years worth of spending in cash would not be unreasonable in that sort of a situation, but everybody is going to be different. I think you probably ought to have some on hand that will keep you from having to sell assets low.

All right, here’s another question. What about some of the fancy withdrawal strategies like those that depend on a cyclically adjusted price to earnings ratio or the CAPE ratio to determine how much to withdraw each year? I’m not a big fan of complicated withdrawal strategies. I like the Taylor Larimore withdrawal strategy, which is basically every year look at what you have and make some adjustments in how you live based on that. If you’ve had a lot of good years, feel free to spend or give some more money. If you’ve had a few bad years recently, I think maybe I’d tighten the belt a little bit and maybe spend a little bit less. It’s really no different than what you did throughout your entire career. I think adjusting as you go is probably the best plan. Make sure you start in the right neighborhood, somewhere around 4% of your portfolio, and then just adjust as you go.

What should my stock to bond ratio be in retirement? Well, there’s no perfect answer to that question, but there’s a few considerations. One, if you’ve got far more than enough, bear in mind that you really … The game of investing is trying to reach your financial goals while taking as little risk as possible. So once you’ve won the game, stop playing. That’s one school of thought. The other school of thought is, well, the more you have, the more risk you can afford to take and the more you can leave to heirs or to charity and so some people actually take on more risk as they become wealthier.

Of course it’s critical that you don’t exceed your risk tolerance, though. The worst thing you can do, either nearing retirement or in retirement, is selling low and just a 2008 kind of market scenario happens. You lose a bunch of money and all of a sudden you lock in those losses by selling low. I mean, that is a financial catastrophe. You really want to avoid doing that. It’s kind of like The Price is Right when you set your stock to bond ratio. You want to get as close to your risk tolerance as possible without exceeding it and that would be a little bit easier if our risk tolerance were stable. The issue is most of us feel like we can tolerate a lot of risk when markets are going up and then all of a sudden when markets start going down, we don’t tolerate nearly as much as we think. I would encourage you, if you’re not sure exactly what your risk tolerance is, because you’ve gone through a big, nasty bare market, to err on the conservative side.

Hopefully by the time you’re approaching retirement, though, you have a pretty good idea what your risk tolerance is. I mean, you’ve been through five or six bare markets by that point, if you’re like most, and so you ought to have a pretty good idea what stock to bond ratio you can tolerate in a market downturn. A lot of investors discover that their risk tolerance gets better over the years. They’re supposed to be having this decreasing stock to bond ratio as they get closer to retirement due to sequence of returns risk, but instead, they’re actually able to tolerate more risk because they’ve learned to do so. They’ve just become used to the market fluctuations.

I mean, I remember in 2008, I really watched closely what the market did. It went down and down and down and down and down and it was pretty fascinating to watch, but I’ll tell you what, it’s been pretty boring since then. The only reason I look at the market once a month is because I write a newsletter where I give a market report in it, otherwise I’d probably be looking at it a couple times a year.

All right, let’s do a few more questions. The rest of our questions for this podcast come from a dentist. He says he looked into offering a 401K for his five employees and himself, but based on the employees, it would be extremely expensive to make it worthwhile. That’s not unusual. The alternative would be to offer a simple IRA, but then I wouldn’t be able to do the back door Roth IRA anymore, plus it would only allow me to put in $12,500 for me and $12,500 for my wife and my employees are okay with their current benefits, so I’m thinking about just sticking to after tax investments. What do you think?

Well, I think that’s a fine plan. The truth is, once you have employees for your practice, whether you’re a dentist or a dental specialist or whether you are a physician, once you have employees in there, a retirement plan is no longer a do it yourself project. If it’s just you as an independent contractor, go get yourself an individual 401K. But if you have employees, you can’t do that. So you really need to get an expert in there to look at your practice and look at the ages of your employees and how much they’re likely to save and how much you want to save and kind of do a study of it and decide what’s right for you. Sometimes that might be a simple IRA. Sometimes it might be a SEP-IRA. If the option is one of those choices, you’re not going to be able to do a back door Roth IRA.

Maybe it makes sense to have a 401K of some type and then sometimes it might not make sense to offer anything to your employees. You’ve really got to dive into the weeds here and have this discussion with a professional and your employees and decide where to go. Certainly you can save for retirement in a taxable account. Between your taxable account and your back door Roth IRAs, maybe that’s all you do and that’s okay. You can certainly save enough in those.

He gives me a little follow up email and says, “I’ve always been a little surprised by the idea that residents and fellows should learn financial literacy from the ACGME or through some aspect of their training programs. After all, I didn’t expect the attendings in my residency to teach me how to prepare healthy meals or to lead exercise classes at the end of the day, which is arguably more important than financial wellness. Clearly the WCI universe content is so much better than anything the ACGME provides on financial literacy. Let the ACGME in residency just simply distribute your book or at least a link to your website rather than trying to teach residents about everything under the sun.” Boy, that’d be awesome if they’d do that. “That said, props to the scattered academic docs out there talking to their residents and giving them the basics of financial literacy.”

Well, here’s the deal. I mean, you spend so much time in training between medical school and residency and fellowship. What’s a couple of hours here and there of financial literacy? I don’t think we’re asking too much here to have a little bit of that in medical school and a little bit of that in residency. I mean, obviously this is never going to take the place of your primary specialty training, but it wouldn’t be that hard to once a year give a few hours of financial kind of stuff. I think there’s plenty of room in the curriculum for that and certainly the focus on wellness that we’ve had the last few years is probably worthwhile doing.

All right. If you spend any time on Reddit at all, be sure to check out The White Coat Investor sub Reddit. It’s not as active as I’d like to be and it sure would be nice if we could get a core group of people there, dropping in there each week like we have on the forum and the Facebook group. There are a lot of people on Reddit and I think the WCI message isn’t getting to them as well as I’d like to see. So if you like Reddit, please stop by The White Coat Investment sub Reddit once a week or so, answer some questions from people and let’s see if we can build a community there as well.

This episode was sponsored by Alexis Gallati of Gallati Professional Services. Alexis is not your typical tax advisor. With over 15 years of experience, she has been helping physicians all over the country save money on their taxes. As the spouse of a busy physician, she understands the burden of high tax payments physicians incur during their lifetime. Not only will she create a high level strategic tax plan for you, guaranteeing money in your pocket, but Alexis will proactively work with you throughout the year to maintain your tax plan, prepare your annual tax returns and represent you in case of an audit. The investment in her tax planning services is a fixed price agreement and her tax maintenance packages are a flat monthly fee. If you’re tired of complex tax jargon and giving away most of your paycheck to the IRS, visit Alexis’ website at www.gallatitax.com. That’s G-a-l-l-a-t-i tax.com today to schedule your free initial consultation.

Head up, shoulders back. You’ve got this. We can help. The whole White Coat Investor community is here to support you in reaching your financial goals. We’ll see you next time on The White Coat Investor podcast.

My dad, your host, Dr. Dahle is a practicing emergency physician, blogger, author and podcaster. He is not a licensed accountant, attorney or financial advisor, so this podcast is for your own entertainment and information only and should not be considered official personalized financial advice.