It’s All About Cash Flow

The happiest retirees have a confident cash flow plan.

A confident cash flow plan doesn’t mean it’s bulletproof. The future is unknowable. Uncertainty is never eliminated.

A confident cash flow plan requires you to buy into the process. A smart retiree needs a general understanding of their investment process. You may not understand the details of the strategy, but you need to fully embrace the system.

By achieving financial freedom you have a master’s degree in building wealth. Managing cash flow in this stage became second nature for you.

Using your investment portfolio to create cash flow requires a different framework. By default, the average retiree believes this means a focus on dividends and interest.

This is a common fallacy. Historically dividends and interest paid a meaningful cash flow to investors. In today’s world, this is no longer true.

Cash flow from a portfolio is based on safe withdrawal rates. Your cash flow is likely a combination of dividends, interest, capital gains, and a return of principal.

What is a safe withdrawal rate?

A safe withdrawal rate came from retirement cash flow research that wanted to understand…

How much can I spend in retirement without running out of money?

To answer this question the researcher set out to find the “worst date in history” to retire. This leads to finding the most a retiree could have withdrawn from their portfolio each year.

Bill Bengen is the original safe withdrawal rate researcher. He intuitively understood retirees wanted to maintain consistent cash flow. This meant finding an initial withdrawal and providing inflation increases each year.

Bill’s research uncovered the popular rule of thumb – the 4% rule. The first piece of research on this topic identified 4% as the safe withdrawal rate. It has since influenced many iterations of research.

If you want a deep dive into the various research check out Wade Pfau’s book and a blog written by ERN.

Michael Kitces is one of the researchers you will find in those resources. One of his papers summarizes 20 years of research on safe withdrawal rates.

This article combines the different factors that influence a safe withdrawal rate. This creates a “layer cake” leading to a safe withdrawal rate.

Michael caveat’s this summary the best by stating:

“…many of the factors discussed here were evaluated in separate research studies, and it is not necessarily clear whether they are precisely additive.”

Even with that caveat in mind, there is a ton of value in understanding how each factor influences your cash flow in retirement.

What are the factors that influence safe withdrawal rates?

To get a feel for the impact of the various factors check out the calculator I created by clicking the link below. This isn’t an exact reflection of the article. Its sole purpose is to educate us on the various factors that influence a safe withdrawal rate.

20 Years of Safe Withdrawal Rate Research Calculator

Within the spreadsheet I broke it into three groups:

1. Controllable –> You 100% control these decisions.
   • Fees net of expected investment outperformance
   • Buy and hold vs Tactical Asset Allocation
   • Single country bias vs Globally diversified portfolio
2. Preference–> Your preference on prioritizing certain trade-offs.
   • Spending flexibility
   • Legacy/Longevity hedge
3. Facts –> These are your facts. You have limited to no control over it.
   • Tax drag on taxable investments
   • Time horizon
   • Valuation environment

Over time I might dig into the details of each topic.

If we focus only on the controllable decisions what do we see?

Jack Bogel said it best “we get what we precisely don’t pay for.” Lower your fees, increase the amount you can spend on everything else.

Investment outperformance (alpha) can only be achieved using an active trading strategy. By definition, a low-cost, buy and hold investment strategy will not outperform the index. It will track the index before accounting for fees. Expecting alpha is only valid if you use a valid strategy. Gut feeling investing is not valid. Be careful here.

The next two factors are

• Buy and hold vs Tactical Asset Allocation
• Single country bias vs Global diversification

Which choices increase your withdrawal rate?

• Tactical Asset Allocation – 0.20%
• Global diversification – 0.50%

Why do these choices increase your withdrawal rate?

Because both choices are proven to decrease draw downs.

If you reduce draw downs then you increase your withdrawal rate.

Since happy retirement is all about cash flow. Why would you choose to invest without using a strategy to manage drawdowns?