How Should I Invest During Retirement?

A reader writes:

“I would like your opinion on an investment strategy. I’m sure you cringe at anyone who asks for investment advice, however, this question is very big picture. I have five years before I retire and I am considering discontinuing my investing in our Roth IRAs and my Thrift Savings Plan and just letting them compound until I hit 60. I want more flexibility in our investments, meaning, I want to be able to tap, should I choose, the dividends in our 40s and 50s as well. My plan is to bypass this money into another rental property and when that is paid for, bypass all my investment cash to index funds. The idea is that we’ll have passive cashflow via our rental and at some point, dividends from index funds, on top of my military pension.”

No worries and no cringing. I get the “how to invest” question a lot, and there are many paths to that success. The key is choosing an investment allocation which you’re comfortable with in both bull & bear markets, and one that requires minimal effort to maintain. If you have to keep making investment decisions every month, then pretty soon you’ll be overwhelmed by behavioral psychology’s deadly duo of decision fatigue and ego depletion.

Your plan seems sound. Ideally, your TSP and Roth IRAs are compounding at least as fast as any new contributions would boost them, and new contributions may not have as much of an effect. It sounds like you’ve already proficient at landlording, and those rentals could help cover the rest of your retirement expenses. If you need more cashflow then you can find plenty of low-expense index dividend exchange-traded funds and mutual funds for taxable accounts.

I have an asset allocation suggestion, but again the important part is keeping your comfort zone and “sleep at night” security. You can optimize your investments with cold-hearted Vulcan logic, but if it’s too hard to follow during a bear market (or too stressful) then it doesn’t matter how logical it may be. Here’s the suggestion: when you’re drawing a military pension and cashflow from rental properties, then your overall asset allocation is hugely overweighted (in a good way) in bond-like income. In that situation you might want to consider holding only equity funds in your TSP, IRAs, and taxable accounts.

You could load up on equities by selling the “F”,”G”, & “L” funds in your TSP and buying “C”, “S”, & “I”. In your IRAs and taxable accounts choose solid, large-cap, boring equity dividend funds like a cheap passive index dividend mutual fund or the iShares Select Dividend ETF (DVY) or a low-expense dividend mutual fund. Don’t invest in REITs until you’re ready to start selling off the rentals. In your tax-deferred accounts, reinvest the dividends for as long as you want. In the taxable accounts, take the dividends in cash for spending on your budget.

Instead of keeping bonds or bond funds for your retirement, keep two years of expenses in cash. (“Expenses” means “the gap between your income and your budget.”) If you want to chase yield a little, then put one year of cash in a money-market account and ladder the rest in three-year CDs.

This stash can be replenished every year when the markets are up, and drawn down for a second year when the markets are down. (Two years will get you through just about every bear market. Three years might be overkill.) Once or twice a decade you may have to break into a CD before it matures, but otherwise your pension, rentals, dividends, and the money market fund could cover your spending. If you feel nervous about replenishing your two-year cash fund by selling shares from your taxable account (the one with the equity dividend fund) then you could always consider withdrawing the contributions from your Roth IRAs.

[2017 clarification:  this is only done to handle sequence-of-returns risk in the 4% Safe Withdrawal Rate. That generally applies only during the first decade of the 30-year portfolio survival, and that risk dwindles during later years. After 10+ years of financial independence, the portfolio will probably (>80% chance) grow big enough to do away with the cash allocation to two years’ expenses. After that you’d simply keep replenishing your checking account by selling shares every year, but by then the portfolio would be big enough that the withdrawal would almost never exceed 4% of the portfolio’s value.]

Just to hammer this concept into the ground, here’s a six-year example of dealing with a bear market. The purpose of this example is to show you how to manage your cashflow, and I’m going to start with fictional numbers from a ridiculously large budget. If you’re living in a low-cost area then the rental income may seem right for one or two rental properties, but if you’re living in a high-cost area then the rental income may seem way too low. Your asset allocation (and the value of those assets) may differ considerably from this example– but they’ll use the same cashflow techniques.

Budget: $80K/year (everything, including taxes).
Pension: $45K/year.
Net rental income (after expenses, before taxes): $10K/year.
Interest & dividends from taxable accounts: $10K/year.

Your retirement budget exceeds your income by $15K/year, so you decide to keep two years of those excess expenses in cash. You start each year with $15K in your money market fund, and you keep another $15K laddered among three PenFed three-year CDs.

(Note that if you’re using the 4% safe withdrawal rate and you’re withdrawing $15K/year for your expenses, that translates to investments of $375K (= $15K/0.04). You saved those assets in taxable accounts before you retired from the military. You’ve invested them in a dividend fund which yields $10K/year or 2.7%.)

At the end of the first year of retirement you spent $15K out of the money market fund, so you replenish your cash stash. (You sell some shares from your taxable assets: your equity dividend fund.) You start the second year with $15K back in the money market fund and you still have the $15K in your CD ladder.

The following year your rental income rises to $12K and your dividend funds have raised their payouts by another $2000 to $12K, so now your income is $69K. You boldly decide to reset the money-market fund and the PenFed CDs to $11K each, so when a CD matures you move cash around to start the third year with $11K in the money market fund and $11K laddered in PenFed three-year CDs.

The third year everything gets ugly. You spend $81K (over budget), you have a lengthy vacancy and repair expenses in your rentals, and the stock market drops 20%. Your rental income is back to $10K. Although your equity dividend fund shares are worth 20% less, your dividend income stayed steady at $12K (this is why people invest in dividend funds). You chew through the $11K money market fund by September and decide to break one of the CDs (losing six months’ interest as an early-redemption penalty). At the end of the year the stock market is down so you do not replenish the money market fund, and you only have about $8K left in the CDs. The coming year looks grim– as bear markets always do.

Several things happen during the fourth year. You reflexively cut your spending by holding the line on expenses. However, it happens, it’s human nature to reduce spending during a bear market. Maybe you defer some home improvements or drive an older car for another year. Maybe you take a two-week staycation instead of traveling. Maybe you cancel a gym membership and dine out a little less. Your spending drops to $75K, your second CD matured, and you had to break the third CD (for a second early-redemption penalty). At the end of the year both your money-market fund and your CDs are empty.

During the fifth year (after two years of a bear market), your military pension rises to $46K because of the cost-of-living adjustment. The stock market improves a little. Your dividend income goes up to $13K (this is why people invest in dividend funds). Your rental income recovers to $12K. You were thinking hard about withdrawing some the contributions from your Roth IRAs (no tax, no penalty) but you felt that your equity portfolio (in your taxable account) was recovering. Your income was still $4000 less than your $75K budget. You elected to cover that $4000 gap by selling shares of your dividend fund which had the highest capital gain.

During the sixth year (after a three-year bear market!) the markets recover smartly. You sell some more shares of your dividend fund to begin replenishing your money market fund and CD accounts. By the end of the sixth year you’ve sold enough shares to bring your spending back up to $80K/year and you’ve managed to set aside $11K in both your money market fund and your CDs.

You also note that your taxable account may not last for 30 years when a bear market happens early in that period. You sold a lot of shares for spending cash and the rest of the account may not recover quickly enough to avoid being used up before the 4% rule’s 30-year period. You’re relieved that you didn’t have to break into your Roth IRA contributions, but they were there if you needed them. You may be tapping your TSP closer to age 60 than age 70. However, your military pension income and your rental income are likely to rise with inflation, and you know that you can vary your spending with your comfort level.

In Hale Nords, we’ve been managing our cashflow this way for nearly 12 years.  The 2001-03 recession was grim, as was 2008-09. Both periods depleted our two-year cash stash, and we nearly sold other shares to cover our expenses– but the markets recovered before we reached that point. We never had to sell equity shares at a loss. We had to break into a couple of three-year CDs, but even after the six-month early-redemption penalties we still earned more interest from this method than if we’d used one-year CDs.

Keep in mind that your retirement portfolio is the only place where I’m recommending a high allocation to equities. Your kid’s college fund might start out high in equities, but by the time they’re tweens then you’re starting to buy bond funds and I bonds. By the time they’re in high school you’ll be almost entirely in I bonds and CDs. The same short-term goal applies when you’re saving to buy more rental properties– you’d probably want to save up a 20% down payment in CDs instead of equities or bonds.

One last note of caution: one of my military retiree friends already has several rental properties and he’s excellent at finding more. Every year or two he buys another irresistible deal, and so far it’s worked out great. However, it could turn into a second career and he has yet to decide on an exit strategy. Enjoy the landlording as long as you’re having fun, but figure out your exit strategy (even if it’s “probate”) and learn when to shut off your bargain detector.

A final disclaimer: I’m not a CFP, just an experienced military retiree who reads a lot of finance books. If you’re seeking a CFP’s advice for an hour or two of fees then I’d recommend starting your search with Jason Hull or Jeff Rose.

[2017 update:  fee-only CFP Forrest Baumhover at Westchase Financial is also an expert on these questions, and a military retiree.]

Related articles:
Asset allocation considerations for a military pension
Tailor your investments to your military pay and your pension
How much will military veterans leave on the table?
“Present value” estimate of a military pension
So you want to be a landlord.
Book review: “Rent vs. Own”
Questions on the 4% “safe” withdrawal rate
Retiring on multiple streams of income
Handling your cashflow after the military
TSP withdrawal options
Three reasons to keep your retirement savings in the Thrift Savings Plan
Guest Post Wednesday: The importance of your retirement account Exit Strategy.

About Doug Nordman

Author of "The Military Guide to Financial Independence and Retirement" and co-author of "Raising Your Money-Savvy Family For Next Generation Financial Independence."
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6 Responses to How Should I Invest During Retirement?

  1. Jason Hull says:

    Nords – Thanks for the shout out.

    Recently, there’s been new academic research from Pfau and Kitces about changing the “equity glide path” for the shoulder years of retirement. I discussed how it applies to early retirees (which, for all intents and purposes, military retirees are) here:

  2. Doug Nordman says:

    You’re welcome, Jason, you’re helping a lot of military people!

    I completely agree with Pfau & Kitces’ analysis. The challenge will be convincing retirees (let alone elderly investors) that they have nothing to fear from volatility. Hopefully a cash stash approach helps them find their comfort zone.

  3. DC says:

    This is very good advice and in practical detail. Thanks for that.

    I’m a little fussy on the mechanics of the 2nd year CD ladder.

    You mention that the (let’s use) $15k for the 2nd year would be laddered in 3 CDs. How does that work? You keep $5k in a CD that matures in one year, another $5k in a CD that matures in 2 yrs and another CD in a CD that matures in 3 years? I’m guessing not, since that would only give you $5k (CD #1) at the beginning of year two, and you’d have to wait another year for another $5k (DC #2), which would not cover your your 2nd year expenses of $15k (in the case of a bear market).
    I’m sorry if I’m overthinking this. Thanks in advance,

    • Doug Nordman says:

      Very good question, DC! Thank you for stepping up to ask it– I fear you’re not the only one who might be overthinking it.

      You’re correct– that’s exactly how the CDs would be laddered. In general, three-year CDs offer the benefit of a higher medium-term interest rate with a lower penalty for early redemption. Otherwise we’d use seven-year CDs.

      After years when the stock market was up (or flat), I’d replenish the money-market cash (by selling shares from our asset allocation) and let the CDs roll over to their new terms.

      After years when the stock market was down, I’d stop selling shares to replenish the money market. During that next year I’d cash in the first three-year CD when it matures, and during the second year I might cash in the second three-year CD. If it’s a nasty recession then I’d take an early redemption on the third CD (and give up the six-month penalty). After that I’d start selling shares from our asset allocation in whatever order makes the most sense at the time.

      Here’s a final note which confuses some readers: this is only done to handle sequence-of-returns risk in the 4% Safe Withdrawal Rate. That generally applies only during the first decade of the 30-year portfolio survival, and that risk dwindles during later years. After 10+ years of financial independence, the portfolio will probably (>80% chance) grow big enough to do away with the cash allocation to two years’ expenses. After that you’d simply keep replenishing your checking account by selling shares every year, but by then the portfolio would be big enough that the withdrawal would almost never exceed 4% of the portfolio’s value.

  4. Rick says:

    Hi Doug:

    I’ve really enjoyed reading your story and posts, very informative and comforting to know things should be ok if you develop a smart plan and stick with it. As a civilian TSP investor I’m hoping to retire in about a year at the age of 50 with the ability to withdraw penalty free. I was wondering what your asset allocation in the TSP would be if you were me? Thanks!

    • Doug Nordman says:

      Rick, you’ve asked one of those outstanding questions that the financial professionals answer “It depends.”

      It depends on your other sources of income (part-time work after retirement? pension? annuities? Social Security? investment rental properties?) and on your tolerance for volatility. It also depends on your asset allocation in your accounts outside of the TSP, and whether you want to match that across your entire portfolio. It also depends on your ability to convince your spouse and family of the wisdom of your choices, especially during bear markets and recessions.

      The easiest way to figure out the answer is with a fee-only CFP. You could search for one from NAPFA, the Garrett Network, or XY Planning Network. I also refer military families to fee-only CFPs who work online with clients who are stationed all over the world.

      It’s a good idea to read up on the process, and Bogleheads has a great wiki to help you navigate the details. Click on the “Getting started” link or skip around to specific areas:

      You might also decide that you’d prefer a financial coach, not a CFP. (Coaches can do everything that a CFP does except recommend specific investment funds or stocks.) There are approximately a gazillion of those in business with varying programs, and Dave Jacobson at Coach Connections might be able to offer a referral.

      And of course you can e-mail me questions at NordsNords at Gmail whenever you want a second check.

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