What follows is a “hands on” approach to taking good care of your retirement money. Keep in mind that everyone has different needs, aspirations and plans – meaning your retirement plan will be unique. One size does not fit all.
There is a logical and commonsense approach to how you can have a worry-free retirement without financial headaches, and it is presented in a book by David Vick. Dave is a financial planner and his book for the retirement minded is: Bat-Socks, Vegas and Conservative Investing. Dave calls his approach the ABC Planning Process.
To start you should imagine that all the money you’ve saved for retirement is in cash – not the case of course, but assume it is. You’re 100% liquid and can invest wherever you want. How would you re-invest the money and why? What assets would you hold – stocks, bonds, mutual funds, bank CDs, annuities, real estate, options, commodities or something else? Most people don’t know what they would do if they could start over, but by using Dave Vick’s ABC Planning Process it is easy to decide which assets to own and how much of each.
Imagine that all the retirement money you have will be put into three buckets – a green bucket, a yellow bucket and a red one. This green, yellow and red color scheme resembles a stop light at a busy intersection: an intersection with lots of cars, crazy drivers and a high risk of having a wreck. An intersection, much like the crossroad of working years and your retirement years: conflicting signs, uncertainty and the potential for bad financial decisions that could wreck your retirement plans.
Let’s start with the green bucket. The money you put in the green bucket is your “protected growth money”. From the green money you should expect potentially moderate growth along with safety of your principal – no possibility for loss. Just as a green light means safety, so does the green bucket. In addition to safety for your green money, you’ll also want some liquidity, tax deferral would be nice and peace of mind is a must.
There are three rules for green money:
1. Your principal must be protected.
2. If you had earnings last year, they should be added to your principal and cannot be lost in the future, i.e., retaining your gains is a must.
3. Green money can be turned into a lifetime of income you can’t outlive.
The best example of green money would be fixed annuities because all the green money rules are met. Green money could also include cash value life insurance, certain government savings bonds like Treasury Inflation Protected bonds and possibly other safe money options. To use a golf analogy, green money is what you’ll need during the front nine of retirement. Since the green money is your safe money, how much you want in the green bucket will depend on how much retirement money you have, what would be the consequences of losing some of it and your tolerance for risk? If you can’t sleep if your money is at risk, then relatively more of your retirement money should be green.
The yellow money is what you’ll need for everyday expenses and to pay for unexpected emergencies. Yellow money will earn a low rate of return because it must be safe and have high liquidity. Yellow money should have no risk of loss. Liquid means it can be turned into cash on short notice and without suffering a loss. Examples of yellow money are bank CDs and deposits, savings accounts, money market accounts, very short-term government bonds and other safe assets that are matured or due to mature very soon.
The red money is what is at risk and in danger of loss. If the risk is high then generally the potential return is also high. The red money is earmarked for the back nine of retirement or is money you’re unlikely to need for retirement. Red money could be the legacy you want to pass to your loved ones or a favorite charity. How much you put in the red bucket will be determined by several things including your attitude about risk, past experiences with risk, how much money you’ve saved for retirement, the consequences of suffering a loss and your peace of mind or ability to sleep knowing losses are possible. Examples of red money places are stocks, bonds, mutual funds, variable annuities, REITs, options, ETFs, commodities and other investments that can go up and down in value. Naturally the percentages of green, yellow and red money chosen will vary widely by retirees, even among retirees with the same amount of retirement savings.
There you have the three hues of money – green, yellow and red. Since you’ve assumed all your money is liquid and you could put it anywhere you wanted, what percent would you put in each bucket? Without thinking too hard, write down the three colors and put a percentage beside each that you feel is appropriate for your circumstances. It could be 60% green, 20% yellow and 20% red or any other percent with which you feel comfortable. There is no right or wrong answer – just jot down what you’re thinking.
Not an easy assignment, is it? Not for sure you got it right, are you? Not to worry because most retirement-minded people have trouble making allocations to the green, yellow and red money buckets. Maybe there is a better way.
Let’s first work on the yellow money. If you considered all your income sources – pension, minimum required withdrawals from IRAs, Social Security benefits, income from rental property and other money coming in you can count on, you’d have your total income. If you then subtracted all your expenses like food, medicine, housing, household purchases, clothing, entertainment, taxes, insurance, travel and others, you’d have your total outgo. If your outgo exceeds your income, you’ll need to reserve a few years of the shortfall and put that money in the yellow bucket. If your income is sufficient to cover expenses, you’ll only need to reserve for emergencies and other big ticket purchases you’ve planned for the next few years: new car, boat, dental work, helping kids with college, home repairs, etc. You’d also put this money in the yellow bucket. The yellow bucket amount is the easiest to determine, but if you keep more than needed in the yellow bucket you’ll be giving up earnings. Overdoing the yellow money is a common mistake of many retirees because they keep most, or all, of their retirement money in bank deposits as if it were going to be needed tomorrow. Remember, no risk means low returns, and low earnings could mean less for your retirement years.
Now let’s jump to the red money. A good rule of thumb that Dave Vick uses, and which is a standard in retirement planning, is called the Rule of 100. This Rule of 100 says to subtract the age of the oldest spouse from 100 and express the answer in percent. This percent is the most that should be kept in the red bucket. For example if the oldest spouse is 72, then no more than 28% should be in the red bucket: 100 – 72 = 28, or 28%. The world will not end if you miss by a few percentage points because the Rule of 100 is a guideline, but you’ll want to stay close to the percent shown by the Rule of 100 unless you have unusual circumstances.
Since the yellow money and the red money have been determined what’s left must go into the green bucket, right? Pretty simple approach to allocating your retirement money into the right categories and you’re encouraged to go through the exercise. The ABC Planning process helps you determine how to allocate your retirement money among the various options. Of course your retirement money is probably not 100% liquid, so you now will be faced with actually implementing your ABC Plan into green, yellow and red money. Let’s review the colored buckets into which retirement money should go.
First is the percentage that will be needed for daily living, expected large purchases and emergencies for the next three to five years. This will be your yellow money. Yellow money is best kept in bank CDs, savings & checking accounts, money market accounts or other safe places. Yellow money can be turned into cash quickly without loss.
Second is the red money. The proper amount can be determined by using the Rule of 100. The guideline is 100 minus the age of the oldest spouse expressed as a percent. Your red money will potentially have a higher growth rate but will also have higher risk of loss. Red money places are stocks, bonds, mutual funds, variable annuities, options, commodities, REITs and other market investments. This money may be convertible to cash quickly but you could also suffer a significant loss. Red money is for the back nine of your retirement.
The rest of the money goes into the green bucket. This is protected growth money that has the potential for moderate growth but is safe from risk. It is kept in fixed annuities, index annuities and possibly super safe short term bonds. The three rules of green money are: (1) protection principal, (2) earned gains are retained, and (3) at your option can be converted or used for a guaranteed lifetime income.
You now have the percentages you’d want if you could do it over again. Compare this to where you are now. Simply review all your current investments, savings and cash holdings and put them in the green, yellow or red buckets. Compute the percentage in each bucket and compare to your “ideal” position. Dave Vick’s book does this by showing you before and after color pie charts. Would you believe that most retirees would like their pie chart to have a large green slice and a small red slice? And would you also believe that most retirees actually have a pie chart that has a large red slice and a small green slice? If the two are different you will want to start re-arranging until you get to your ideal.
A word of caution: it is recommended you work with your financial advisor to do the re-arranging. To get the best results you’ll need professional help unless you’re a financial expert or are willing to become a financial expert. By going through the exercises suggested above, you should now have a good idea of what you want and where you are currently. Unless you are willing to make the needed changes, you will continue to face a very dangerous intersection where retirement mistakes are easy to make. The typical retiree needs a professional chauffer to take them through the intersection where working years turn into retirement years. Unfortunately far too many attempt the crossing without help and suffer a market crash, wrong turn or other mishap that causes them to realize their greatest fear: running out of money before retirement ends.
David Vick’s ABC Planning book (Bat-Socks, Vegas and Conservative Investing) can be purchased at: www.lulu.com (do a search for David Vick). It’s a fun read and chocked full of great stuff that will help you have a better retirement.
Shelby J. Smith, Ph.D.
March 2011
