An immediate problem I must solve is to create a buffer (of cash) for the next few years. I’m going to play it very safe by holding cash but it will provide me with some assurance that I can weather a downtown in the stock markets.
I have a budget and so I have some confidence in understanding how much money I should need each year. The budget provides me with a minimum spend. It doesn’t include e.g. vacations.
There’s a commonly used rule of thumb that suggests that it’s possible to spend 4% of your retirement savings each year to (a) provide a stream of income each year; (b) not run out of money.
I’m going to adopt, what I hope is a more accurate (estimate), by mirroring the approach used by the US Social Security system. The US Social Security has a Life Expectancy Calculator. In this approach, each year I will determine my life expectancy. This is currently approximately 30 years. I will need my retirement savings to last me 30 years. So, I simply divide what I have by 30 to get this year’s withdrawal amount. This number turns out to 3⅓% (0.0333…).
Next year, I will need to redo this calculation because:
- be a year older
- have a different life expectancy
- have a different balance for my retirement savings.
NB It’s possible that my life expectancy won’t simply decrease by 1 year for each year I get older.
This reasonable (!) withdrawal amount exceeds my budget.
Because I’m just starting out on my retirement, I don’t have the full 5-year buffer established. So, this first year, I’m going to realize 5-years' money at one time. I will save this money in high-yield savings accounts and I will consider building a CD ladder. However, this means I must now estimate how much I should need for the next 5 years.
For simplicity’s sake, I’m going to just multiply this year’s budget by 5 (years) to determine how much I will need. I already have some cash and so only need to realize the difference between what I need and what I have. I may only spend from my non-retirements accounts, i.e. I cannot yet use any 401(k) or IRA monies.
Now to represent this data in the spreadsheet.
My annual budget works out to be $25 (of the notional $1,000 I have in overall retirement savings). I’ll review my budget against this notional amount in a subsequent post. According to my life expectancy (of 30 years), I may safely withdraw ($1,000/30) $33.33 this year from my retirement savings. This is more than my $25 budget. I’ve added a sheet called
Constants with a value for
LifeExpectancy. Feel free to adjust this for your purposes.
The spreadsheet shows (
Savings!D2) that I have 9% of my assets in cash but the spreadsheet did not previously show the breakdown between retirement and non-retirement savings. I’ve added rows and ☑ in Column A indicates that the account is a retirement account. I don’t hold any cash nor property in retirement accounts. I’ve rebalanced the spreadsheet to show the savings by each asset type and whether the money is in retirement or non-retirement accounts. The total is the same (of course) and everything tallies to 100%.
I’ve added 2 columns:
2020 ($) and
2020 (%). These show the money I need to have in each asset for next year including the $166.67 (5 years of $33.33 withdrawal) cash. You’ll note the cash column for
2020 ($) is greater than $166.67. This is because, I don’t want to have $0 in cash in 2025!
This is where the spreadsheet helps. I’ve added another 2 columns:
2025 ($) and
2025 (%) and these show the balances I want to have in each asset class come 2025. My savings balance in 2025 will be (assuming no other changes) this year’s balance less the 5 years' cash that I plan to spend ($1000 - 5*$33.33 = $833.33). I can’t spend money in retirement accounts nor will my property asset change. So those just carry forward.
I’d like to have 40% in Domestic Stock, 20% Foreign Stock and 20% Domestic Bonds. Given that I can’t change the amounts (!) in these assets in the retirement accounts, I simply find the differences as percentages (see the orange-colored cells in
2025 (%) column). Given that my total assets will be
$813.33, I can calculate how much non-retirement Domestic Stock value etc. I will need. To bring the total to 100%, I leave the rest in cash (6.8% which is $56.67) which I add back to my
2020 ($) cash total. Phew!
The next step will be to identify which stocks and bonds in my non-retirement accounts I will sell in order to bring my assets into this proposed alignment, realizing sufficient cash for the next 5 years. In subsequent posts, I’ll discuss both of these
I’ve added another sheet called
Summary that shows the asset totals across retirement and non-retirement accounts.