Retirees: Find a Sensible Plan for Liquidating Your Assets

If retirees and pre-retirees came away with one key concept following the bear market of 2007 through early 2009, I hope that it's not that they don't belong in stocks at all. Given increased longevity rates, even conservative retirees need the boost that stocks can add to the longevity of their portfolios.

Instead, a better takeaway is that you need to have an adequate cash pool on hand to ensure that you don't have to tap your stocks for living expenses when the market is at a low ebb. That's the "bucket" approach that financial-planning gurus Harold Evensky and Deena Katz employ in their own practice and discuss in their book, Retirement Income Redesigned: An Advisor's Guide for Funding Boomers' Best Years. 

Having adequate cash on hand to pay for living expenses can help counter investors' own worst tendency to panic-sell at the bottom, as Evensky discussed in an interview with me last year. "There is a phenomenal comfort factor in knowing that you can pay your bills from your money market reserve account and you can afford to wait for the world to get more rational," he said.

So let's assume that you want to employ some version of the bucket approach in your own financial plan. Easy, right? Not exactly. To make the bucket approach work, you need to have a plan for filling up your cash bucket periodically. If every few years you grab indiscriminately from your long-term assets to raise cash for your living expenses bucket, you're no better off than if you didn't have a bucket system at all.

Unfortunately, there's no single strategy for filling up your cash-flow bucket that makes sense for everyone. What's right for you will depend on the nature of your long-term assets, the types of vehicles that hold those assets, and last but not least, your own personality and appetite for portfolio maintenance.

For many folks, employing one of the following strategies (or perhaps a combination of them), will make the most sense.

Make It Part of Your Routine
One approach to bucket management would be to simply move set dollar amounts from your long-term bucket to your cash bucket at regular intervals, say every month, quarter, or year. (You could also create a three-bucket system, as I discussed in this Portfolio Makeover: one holding at least two years' worth of living expenses in cash; one holding intermediate-term assets such as intermediate-term bonds and conservative balanced funds to cover the middle years of retirement; and one holding long-term assets such as stocks for retirement's later years or a legacy for children and grandchildren.)

Liquidating fixed dollar amounts from long- and intermediate-term assets on a frequent basis, such as every month or every quarter, helps ensure that you're obtaining a range of prices for those assets--some higher, some lower, depending on the market environment.

Some critics have assailed the strategy of reverse dollar-cost averaging because it guarantees that you'll lock in losses when the market has dropped a lot. That's true, but selling small chunks of assets on a preset schedule also helps ensure that you're selling your winners when their prices are lofty. For example, retirees may be tempted to replenish their cash at some point in the future rather than right now. After all, their long-term assets have probably been doing well. But selling at least part of their winning holdings now would help lock in some profits.

Perhaps a bigger downside of moving money around too often is that it can become a logistical headache and a time suck, particularly if the assets for each bucket are housed in multiple accounts, both taxable and tax-sheltered. Thus, retirees who would like to take a more hands-off approach might put bucket maintenance on an annual schedule rather than doing so monthly or quarterly.

A More Tactical Approach
The approach I've outlined above is appealing because it's so methodical. Because bucket maintenance is systematized and on a preset schedule, there's little room for the retiree to override the process in a period of panic, or perhaps just as important, during periods of market euphoria.

However, an equally valid approach to liquidating long-term assets in retirement accounts could hinge on more fundamental factors such as overall portfolio asset allocation, investment-specific considerations, or taxes. That's the approach that Harold Evensky advocated for in our interview, and it's appealing because it allows you to be more nimble than if you methodically sold assets from your long-term accounts on a set schedule.

Assuming you decide to opt for such an approach, here are some of the key sell triggers to which you might stay attuned.

Investment Considerations
The goal here is to sell those assets that have violated your investment policy statement for one reason or another. (You do have an investment policy statement, don't you?) Perhaps a key manager on one of your funds left or a stock exceeded your price target for it, for example. Or maybe you think one of your fixed-income funds is taking more risk than you bargained for, or you've decided to reduce your exposure to long-term bonds. These are all good examples of fundamentally based sell triggers that would help you fill up your cash allocation when it was at a low ebb.

Asset Allocation/Rebalancing
Even if you're using a bucket approach to portfolio management, it's important to have an asset-allocation strategy for the total portfolio. (Of course, the two concepts should work closely together.) So if you've X-Rayed your portfolio and determined that it's too heavy on stocks, bonds, or other long- or intermediate-term assets, pruning those securities is a perfect way to fill up your cash bucket and get your asset allocation back into whack.

Tax-Related Considerations
One other important consideration for deciding which assets to liquidate revolves around taxes. For example, you may prune losing stocks and funds from your long-term accounts to offset gains elsewhere in your portfolio; rather than plowing the assets back into the same asset class, you could book the loss and move the money to cash. Or perhaps you're taking required minimum distributions from your intermediate-term bucket; that money would also be well-used to replenish your cash holdings. This article discusses optimal asset location, and this one addresses sequencing of withdrawals.

A Combined Approach
Note that the two approaches to raising cash don't have to be mutually exclusive; it's possible--even ideal--to blend the two. Even if you're shifting into cash at regular intervals, as in the first approach, you can still stay attuned to fundamental factors when doing so.

For example, say it's quarter-end, the time of year when you're supposed to refill your cash bucket. You don't have to blindly draw equal amounts from all of your longer-term holdings to do so. Rather, you can prune from those securities that are on the chopping block as a result of fundamental or tax considerations.

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