Franklin, MI
www.nfa1040.com
Originally published 1/20/10 at FiLife.com
My childhood neighborhood had everything a kid could want: A school with plenty of field space for sports and games, a wooded area to explore (and be terrified of) and a community pool.
During summers, I spent most of my time at the pool. When you’re young, there are two ways to exit the pool: the ladder (boring), or the cool way, which was any way other than the ladder. Clearly, there was only one way to do it.
Before you develop enough upper body strength to press yourself high enough to place a knee and raise yourself out of the pool, the ‘cool’ way was as follows:
1. Muster your strength, advance clumsily with elbows and forearms to lay your chest on the edge of the pool deck
2. Pull forward while twisting on your chest and belly far enough to hook a leg over the pool side
3. Continue to twist, pull and drag yourself until you were out
There was one downside to scraping exposed skin against the pool deck: It hurt!
Coolness aside, the ladder is clearly the smarter way to exit the pool. The ladder is also a way to avoid retirement cash flow “clumsiness.” I am talking about a bond ladder, composed of government-backed bonds or bank CDs.
When I first look at the portfolios for new clients exiting the working world, I see a lot of portfolio clumsiness. Most investors understand they need a portfolio of stocks and bonds for diversification, but they frequently abandon time-tested strategies for the latest Wall Street invention.
A bond ladder takes some of the income portion of your retirement savings and places it in bond ‘rungs’ that mature annually. As the rungs mature, you have cash flow for that year.
Each year a decision needs to be made with your financial adviser on whether to spend the cash from the maturing bonds, or instead sell stocks that have risen in value to maintain the desired asset allocation for the portfolio. That discussion is a side benefit of the bond ladder approach: encouraging prudent and deliberative investment behaviors.
Our preferred investment for a ladder is U.S. Treasury STRIPS bonds, which are bonds sold at a discount.
In summary, the key advantages of the bond ladder are:
- A true guarantee of retirement cash (when using government-backed bonds or CDs)
- Allowing risk-taking in other parts of your portfolio
- Avoiding high costs and unknown performance associated with elaborate packaged financial products
If only that were true. A ladder and secure retirement cash flow plan should be the starting point, prior to looking to achieve excess return. Because being ‘cool’ with retirement income carries more hazards than a scraped belly.
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