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Retirement

Capitalize Review–A Free 401k Rollover Service

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Rolling over a 401k to an IRA is a hassle. I know from personal experience. Capitalize, a venture capital backed technology company, looks to take the hassle out of 401k rollovers.

The company offers a free service that handles all of the paperwork to safely transfer a 401k to an IRA. It never has access to your money and can help you choose an IRA if you want. In this review of Capitalize, I’ll look at the details of how the service works and how they manage to offer it for free.

Capitalize QuickTake

Get Started
  • Free 401k rollover service
  • 4.9/5.0 Trustpilot Rating
  • Works with most IRA providers
  • Capitalize never has custody of your money

About Capitalize

Co-founders Gaurav Sharma and Chris Phillips launched Capitalize in 2020. The mission of the company is simple–to make the 401k rollover process easy. It raised $12.5 million in capital earlier this year. It has 17 employees and a TrustPilot customer rating of 4.9 out of 5.0.

Capitalize Review

How Capitalize Works

Capitalize follows a simple 3-step process.

Step 1: Locating your 401k

While this may seem odd to some, many people have long forgotten about an old 401k account. Or perhaps they don’t know how to access it. In step 1, Capitalize will help you locate your 401k if you need the help.

I searched for an old company that no longer exists (they went bankrupt). Capitalize found the company’s 401k plan, to my surprise.

Step 2: Choose an IRA

Here you can use an existing IRA if you have one. Otherwise, Capitalize can help you choose a new IRA. To help you pick an IRA, the tool walks through a number of questions:

  1. Whether you want to manage your investments or have them managed for you
  2. What factors are most important to you, including low fees, long standing brand, easy to use, and access to a human advisor.
  3. How much money you have in your 401k (some IRA accounts have minimum deposit requirements).

Based on answer these questions, Capitalize suggests a number of IRA providers. For me, the top choices were Betterment, Wealthfront, Fidelity and Vanguard, among others.

At this step in the process, you create a Capitalize account with an email and password. Once created, you can click a link to open an IRA account at your chosen firm

Step 3: Submit 401k Info

Finally, you submit information about your existing 401k. This allows Capitalize to initiate the 401k rollover process. I found this process to be extremely quick and easy as I walked through it as part of this review.

What 401k Accounts Does Capitalize Worth With?

Capitalize works with all major 401k providers, as one would expect. This includes Fidelity, Empower, Vanguard and T.Rowe Price. For those with smaller providers, Capitalize allows you to search for your retirement account by your former employer’s name.

How does it do this? Workplace retirement accounts like a 401k must be registered with the federal government. In fact, you can search what are called Form 5500 returns yourself here at the Department of Labor’s website. The search feature is a bit hard to navigate. Fortunately, Capitalize makes it much easier.

If your 401k provider is not listed, just search for your company. Capitalize will then track down the 401k plan for you.

In addition, Capitalize works with both traditional and Roth 401k accounts, as well as 403b accounts.

What IRA Accounts Does Capitalize Work With?

If you need to open an IRA, Capitalize offers a variety of options. These include traditional brokers (Fidelity, Vanguard, Merrill, ETrade, TD Ameritrade), robo-advisors (SoFi, Betterment, Wealthfront), and some newer brokers (Ally, TradeStation).

You can also use your existing rollover IRA account if you have one.

How Long does a 401k Rollover Take with Capitalize?

It depends. It can take from a few days to a few weeks. The time varies because the processes that must be followed vary from one 401k provider to another.

How is Capitalize Free?

Capitalize makes money if a customer opens a new IRA account through its platform. This raises an important question. Does Capitalize’s revenue model influence the IRA accounts that it recommends? According to Capitalize, the answer is no:

If you choose to open up an IRA with one of the providers on our platform then we may be compensated. This helps us keep the service free for users, but none of those providers is ever allowed to impact the content on our site. It also never affects the fees you pay as a customer. If you’ve ever used a site like Nerdwallet, Credit Karma or Lending Tree then you’ll be familiar with this model. Our reputation depends on you feeling like we provide an honest, independent product. 

I can add to their list of sites that earn money through partners RobBerger.com. My site makes money from some of the tools and services discussed on this site, including Capitalize.

My approach to this is simple. I’ll only recommend a product or service that (1) I use or (2) would feel comfortable recommending to my mom or my children. However, you should always be aware of a company’s financial incentives and undertake your own due diligence to make the best decision for you and your situation.

Capitalize Alternatives

At the moment, the only alternative to Capitalize that I’m aware of is to do it yourself. If you take that route, one tip is to contact your IRA provider first. They can often help you through the process, although you’ll have to do all of the legwork.

Final Thoughts

I’ve rolled over 401k accounts a number of times. Fortunately, I’ve never encountered significant issues, but it is a hassle. The last rollover a few months ago required a lot of paperwork, faxing and scanning. It would have been much easier if I had help.

I’ll be rolling over another 401k in December. I’ll definitely be using Capitalize. Why not take the free help?

5 Best Retirement Planners and Apps (#1 is Free)

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Retirement calculators can help us plan and prepare to retire. When we are years away, these online tools can help us determine how much we should be saving. As we approach our time to retire, they can help us understand how much we can spend each year and which accounts should fund that spending.

Not all retirement tools, however, reach the same result. They take different approaches to what is a complex series of calculations and assumptions. One study examined five popular retirement planning software packages and found stark differences in outcomes. As a result, it recommended that individuals use “multiple programs before implementing an action plan based on the results.”

To that end, here is a list of the best retirement calculators, planners and software tools.

Best Retirement Calculators

What follows are my top 5 picks. The first three are retirement planners, allowing you to enter detailed information about your finances both before and after retirement. The final two options are more of retirement calculators. The inputs are much more limited, but these tools give you a quick estimate of when you can retire.

1. Personal Capital

Best all around retirement planner

Personal Capital is my favorite investing and retirement tool. In addition to being totally free, it’s extremely easy to use and rich in features. Once a user connects their 401k, IRA and other investment accounts, Personal Capital pulls all the data from the accounts into its Retirement Planner.

Personal Finance Retirement Planner

The Retirement Planner then allows users to model both income events (e.g., savings, sale of real estate, social security, pensions) and spending goals (e.g., retirement spending, travel, education). Users can also set up multiple scenarios to compare, such as retiring at different ages. Personal Capital then runs the data through a Monte Carlo simulation and reports the likelihood of the plan’s success.

Unique Feature: Users can create multiple scenarios (e.g., different retirement dates, different social security strategies) and compare how successful each will be.

Try Personal Capital

2. New Retirement

Most detailed retirement analysis

New Retirement is not for the faint of heart. The tool, which has both a free and paid version, enables users to model just about every aspect of retirement. For example, users can model social security claiming strategies, medicare coverage, annuities and pensions.

New Retirement Planner Dashboard

New Retirement handles the complexity of retirement planning in two ways. First, users can follow a quick start guide, answer a few simple questions, and have a complete snapshot of their retirement readiness in under five minutes.

Following that, users can dive into the details of everything from future healthcare costs to retirement savings contributions. New Retirement enables users to link investment and retirement accounts or enter them manually.

New Retirement offers three plans ranging in cost from free to $396 a year.

Unique Feature: New Retirement includes a Roth IRA conversion calculator to help users determine when and how much of a traditional IRA should be converted to a Roth IRA.

Try New Retirement

3. OnTrajectory

OnTrajectory is quickly becoming one of my favorite retirement planners. Like New Retirement, it allows you to map out just about everything related to both saving for retirement and spending during your golden years.

OnTrajectory Retirement Planner

It takes just seconds to get started. You’ll answer a few questions, and OnTrajectory will set up a projection of your future savings and spending. From there you can begin to enter data to fine tune every aspect of the plan.

The tool is divided into three sections–Income, Expenses and Accounts. You can link your accounts so they automatically update, or you can enter balances manually. For income, the tool accommodates everything from work to pensions to rental properties. Expenses include every type of expense imaginable, and you can group expenses to make reporting easier.

As for accounts, you can link or manually create 401k, IRA, HSA and taxable accounts. It covers 457B plans (which have specially rules), as well as 529 plans and both traditional and Roth accounts.

Once you’ve entered the data, OnTrajectory uses both Monte Carlo Analysis as well as historical market returns and inflation data to calculate the chances of retirement success. Finally, you can create and compare multiple retirement scenarios.

Unique Feature: You can change the order of accounts withdrawals are taken during retirement or let OnTrajectory calculate the most tax efficient order.

Try OnTrajectory

4. NetWorthify

NetWorthify is designed for those wanting to retire early, although it works with traditional retirements, too. Simply enter your income, annual savings and total savings, and NetWorthify estimates how long until you can retire. It’s free to use.

NetWorthify early retirement calculator

5. cFIREsim

Another free option that I like a lot is cFIREsim. You enter some basic information such as when you plan to retire, current savings, income, asset allocation of your investments and social security values. cFIREsim then calculates the likelihood of your success.

cFIREsim retirement calculator

Retirement Calculators Worth Considering

The following retirement tools didn’t make are list, but still may be worth checking out. In some cases, I’m continuing to evaluate them, and some make make the “best of” list in the future.

Retirement Calculators Not Worth Considering

Here are retirement tools that I believe aren’t worth our time. I list them here to keep a record of what I’ve looked at and so that readers know I’ve considered and rejected these options.

3 Ways Early Retirees Can Tap Retirement Accounts Without a 10% Penalty

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The 60/40 Portfolio for Retirees–Good, Bad or Ugly?

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The 60/40 portfolio has powered retirements for decades. With 60% stocks and 40% bonds, this balanced fund offers equity-fueled growth and fixed income stability.

Today, however, many are calling into question the sustainability of the 60/40 portfolio. Some even argue that it’s dead and that retirees need take on more risk if they want to avoid outliving their retirement savings.

In this article we’ll take a deep dive into the 60/40 portfolio and whether it’s still a viable approach to investing for retirees.

Table of contents

A Brief History of the 60/40 Portfolio

Dating back to 1926, the 60/40 portfolio has enjoyed an annualized return of 9.1% (Source: Vanguard). Its best year, 1993, saw returns of 36.7%, while its worst year, 1931, experienced a loss of 26.6%. Over those 95 years, 22 saw the portfolio decline in value. The returns combined with relative stability have made the balanced portfolio ideal for retirees.

More recent returns show similar results. From 1972 to 2021 a 60/40 portfolio consisting of an S&P 500 index for stocks and intermediate term Treasuries for bonds has returned 9.61% with a standard deviation of 9.51% (via Portfolio Visualizer). The combination of solid returns with less volatility has been ideal for retirees.

In his 1994 paper, certified financial planner Bill Bengen gave us what is now known as the 4% Rule. In brief, the 4% Rule states the following:

  • A retiree can spend 4% of their investments in the first year of retirement;
  • In subsequent years, the retiree can adjust the prior year’s distribution by the rate of inflation; and
  • Following this approach, the retiree should not outlive their money.

Why do we care about the 4% rule? We care because the 60/40 portfolio fits in the sweet spot of the 4% Rule. Bengen found that retirees should hold somewhere between 50% and 75% in equities. In a later book, he identified 60/40 as the ideal portfolio in retirement to avoid outliving a nest egg. Other papers evaluating safe withdrawal rates have reached similar conclusions (as we’ll see in a minute). Some have even evaluated its performance back to 1871!

Notwithstanding the 60/40 portfolio’s stellar history dating back to the post-Civil War era, many are now calling into question its future.

Arguments that 60/40 Portfolio is Dead

There have been several arguments put forth that the 60/40 portfolio is no longer ideal for retirees. All of the arguments stem from the unprecedented financial times we are currently in.

Argument #1: Bond yields are at all-time lows

The yield on the 10-year Treasury sunk to its lowest in 2020 and remains at historic lows. When viewed on a yearly basis, the yield sunk below 2% back in 1941 (1.95% to be precise). Apart from that one year, it remained above 2.00% until 2012 (Source: Shiller). It’s currently at about 1.30%.

During much of the 20th century, the yield was significantly higher. It reached over 14% in 1982. At today’s low yields, many question how a 60/40 portfolio could survive a 30-year retirement.

From Money (4/21/21):

“I think the 60/40 portfolio is antiquated,” says Keith Singer of Singer Wealth Advisors in Boca Raton, Florida. “When bonds used to pay 6-8% and interest rates were falling, the 60/40 model worked great. But as they say, past performance is no guarantee of future results, and that is especially true with the 60/40 portfolio.” (Source: Money).

Argument #2: The 40-Year Bull Market in Bonds Is Over

The second argument relates to the fall of yields over the past 40 years. They hit a high in 1982, and then steadily dropped to their historic lows today. As bond yields fall, the value of existing bonds go up. As such, retirees have benefited from falling interest rates. Unless rates go negative, however, most believe the bull market in bonds is over

If the bond bull market is over, and rates begin to rise, the value of existing bonds will fall. Rising rates can also lead to lower asset values on everything from stocks to real estate, which brings us to the third argument.

Argument #3: Equity Valuations are High (and must fall significantly)

Many point to the richly valued S&P 500. The Shiller PE, which measures price-to-earnings over 10-year periods, is at one of its highest levels.

Shiller PE
Source: https://www.multpl.com/shiller-pe

The argument here is simple. Lofty valuations suggest that stock returns over the next decade will be much lower than historical averages.

At the same time, many argue that the 60/40 portfolio should shift to a greater allocation in stocks. The reason is that while stocks are expensive, the additional long-term returns are needed to offset the paltry returns expected from bonds.

A recent report from Goldman Sachs framed the issue as follows:

The beneficial role of bonds in balanced portfolios has more recently been in doubt given that bond yields close to the zero lower bound offer a diminished returns buffer during “risk-off” periods. These doubts have only increased alongside concerns that an accelerating economic recovery from the pandemic-induced recession, amplified by historically large US fiscal stimulus, could lead to a strong rise in inflation and, in turn, the start of a prolonged bond bear market. During most historical bond bear markets, equities have outperformed bonds and have delivered positive real returns. This has been especially the case over the last 20 years, during which bond bear markets tended to be short and shallow.

Source: https://www.goldmansachs.com/insights/pages/gs-research/reflation-risk/report.pdf

Argument #4: Negative Correlation May be Over

Finally, many believe the negative correlation that stocks and bonds have enjoyed over the past two decades may be over. In a report entitled The End of 60/40, Bank of America analysts warn that bonds may no longer provide the diversification investors have come to expect.

60/40 portfolio diversification

The authors explain,

The core premise of every 60/40 portfolio is that bonds can hedge against risks to growth and equities can hedge against inflation; their returns are negatively correlated,” Woodard and Harris added. “But this assumption was only true over the past two decades and was mostly false over the prior 65 years. The big risk is that the correlation could flip, and now the longest period of negative correlation in history is coming to an end as policy makers jolt markets with attempts to boost growth.

In short, there’s no place to hide.

Arguments that 60/40 Portfolio is Still Solid

All of the above arguments identify real and significant challenges to the capital markets. Interest rates are at historic yields. The 40-year bull market in bonds does appear to be over. And stock valuations are extremely high.

Nevertheless, I believe the 60/40 portfolio is still ideal for retirees. It’s not the only reasonably allocation in retirement, but it will continue to support a retiree for 30 years or more who relies on the 4% Rule. Here’s why I believe this.

Argument #1: Retirees are long-term investors

Those who retire at a traditional age are long-term investors. For a 65-year-old couple, there is a 1-in-4 chance of at least one spouse living past 97 and a 1-in-10 chance of at least one spouse living to 100 (Source: BofA). Retirees could be in the market 35 years or longer. To put that number in perspective, 35 years ago Ronald Reagan was President and Boy George and Mr. T were filing an episode of The A-Team.

The point is that while both equities and bonds may underperform over the next several years, or decade, retirees must consider a much longer time horizon.

Of course, the first ten to 15 years of retirement are critical. Due to the sequence of returns and inflation risk, a devastating market in the first decade of retirement could spell disaster. And that brings us to the second point.

Argument #2: The 60/40 Portfolio has Worked Since 1871

No, that’s not a typo. Researchers have tested the 60/40 portfolio against the 4% Rule with markets dating back to just after the Civil War. It’s never failed.

Michael Kitces, CFP, published a paper showing the maximum initial withdrawal rate one could have taken in the first year of retirement without running out of money over a 30-year retirement. His research tested retirements beginning in 1871.

Initial safe withdrawal rate by year
Source: https://www.genesiswealthmanagement.com/files/documents/SafeWithdrawalRate%20%28Kitces%29.pdf

The lowest initial withdrawal rate was 4.4% in 1966. Some years could have seen an initial withdrawal rate of over 10%. The point is that a 60/40 portfolio has sustained a 30-year retirement through the aftermath of the Civil War, the Panic of 1893, WWI, the Great Depression, WWII, the stagflation of the 1970s, the tech bubble, 9/11, the Great Recession, and the ongoing Covid pandemic.

Argument #3: The 60/40 portfolio offers growth and stability

When compared to a portfolio heavily weighted in stocks, the 60/40 portfolio stands out for its excellent growth and muted volatility. That’s not to say it’s not volatile, but its up and downs are significantly less than a 100% stock portfolio. And that’s precisely what many retirees need.

Since 1972, a 60/40 portfolio has returned an annual compound rate of 9.61%. These returns are lower than a 100% stock portfolio, which returned 10.75% over the same period. What’s notable, however, is the volatility. The standard deviation of a 60/40 portfolio was just 9.51%, while the stock portfolio came in at 15.25%.

To put these differences in perspective, the worst year for a 100% stock portfolio during this period was -37.45%, compared to just -16.88% of the 60/40 portfolio. At the same time, the worst maximum drawdown for the stock portfolio was nearly -51%, compared to -28% for the balanced portfolio.

The increased volatility that comes with 100% stocks brings us to the next argument.

Argument #4: Retirees can stick with a 60/40 portfolio

Studies have shown that investors are not adept at timing the market. Called the investor gap, studies have documented the gap between an investment’s return and an investor’s return. Because investors tend to buy high when stocks are rising and to sell low in a panic when investments fall, they consistently underperform the very investments where they place their money.

One Morningstar study found that investors lost on average 45 basis points due to market timing. There was, however, one bright spot. The study found that investors in less volatile investments performed better. From the study,

When we broke down funds within asset classes based on their standard deviation, we found that funds in the least-volatile quintiles consistently had higher investor returns than those in more-volatile quintiles. This suggests that “boring” funds work well because they aren’t as likely to inspire fear or greed.

A portfolio with more stocks may perform better over the long-term. Investors in retirement, however, need to ask whether they can handle the ride.

Argument #5: The 60/40 portfolio survived rising rates and inflation

No two time periods are identical. Today we face challenges the U.S. and world have never faced. We can, however, look back at similar times to gain an understanding of how the 60/40 portfolio might perform when interest rates and inflation rise. Here I’m thinking of the period from 1941 to 1982.

The yield on the 10-year Treasury stood at 1.95% at the start of 1941. In 1982 it began the year north of 14%. Over the decade leading up to 1982, the U.S. experienced double-digit inflation, with low growth, giving way to the term stagflation.

During this time how did the 60/40 portfolio perform for retirees? Just fine. To be sure, this period is why we have the 4% rule. It represents the low water mark on a safe initial withdrawal rate. But that rate still stands at 4 to 4.5%.

The 60/40 portfolio also performed well more recently when rates began to rise earlier this year. The first quarter of 2021 was the worst for U.S. investment-grade bonds in the last two decades. The 60/40 portfolio did just fine:

“The first quarter of 2021 showed that even the worst quarter for U.S. investment-grade bonds in the last 20 years wasn’t enough to derail the classic 60/40 portfolio”, says Jason Kephart.

So what’s the take for investors. As long as the correlation between traditional asset classes doesn’t shift dramatically and the portfolio continues to rise over time, then holding a 60/40 portfolio still makes sense.

That doesn’t mean investors shouldn’t consider some alternative mixes but perhaps hold those on the margins and keep your core in stocks and bonds. Although, instead of holding broad indexes, they might want to consider diversifying by adding buckets of individual stocks and bonds.

At the end of the day, the most important risk any investor should always think about is the permanent loss of capital and the loss of purchasing power. The 60/40 portfolio still offers the best defence. And even it if did seem to veer off course at one point, it could have been by design.

Source: https://www.morningstar.ca/ca/news/213154/does-the-60%2F40-portfolio-still-make-sense.aspx

Building a 60/40 Portfolio

So far we haven’t discussed the stock and bond investments that make up a 60/40 portfolio. Most of the studies on a balanced portfolio use an S&P 500 index for stocks and intermediate term U.S. bond fund for fixed income. Given current economic challenges faced by retirees, should we further diversify our asset classes?

Warren Buffett would likely say no. The Warren Buffett portfolio he recommends consists of just two asset classes: S&P 500 index and short term U.S. government bonds. He’s bullish on the future of the United States.

At the same time, the U.S. faces significant hurdles. Its population is aging, reducing the workforce while increasing the cost of social programs for senior citizens. The country’s debt to GDP ratio skyrocketed as a result of the pandemic and now stands at more than 125% (Source: The Fed). And our politicians in Washington seem willing to continue borrowing at unprecedented levels indefinitely. Eventually we’ll have to pay for all of this spending.

As a result, some financial advisors recommend moving beyond U.S. stocks and Treasuries. Bob Rice, the Chief Investment Strategist for Tangent Capital made such an argument when he spoke at the fifth annual Investment News conference for alternative investments.

“You cannot invest in one future anymore; you have to invest in multiple futures,” Rice said. “The things that drove 60/40 portfolios to work are broken. The old 60/40 portfolio did the things that clients wanted, but those two asset classes alone cannot provide that anymore. It was convenient, it was easy, and it’s over. We don’t trust stocks and bonds completely to do the job of providing income, growth, inflation protection, and downside protection anymore.”

Source: https://www.investopedia.com/articles/financial-advisors/011916/why-6040-portfolio-no-longer-good-enough.asp

While I don’t share his pessimistic views of the 60/40 portfolio, diversifying to international equities seems reasonable. This could include both developed countries and emerging markets. Other diversification opportunities could include real estate (REITs) and commodities. For bonds, some argue that retirees should take on more credit risk through high-yield bonds and emerging market debt.

Having said that, there’s no guarantee that diversifying the portfolio will lead to better results. A well diversified portfolio has significantly underperformed a basic 60/40 portfolio over the last 15 years (commodities data wasn’t available before 2007 in Portfolio Visualizer).

diversified 60/40 portfolio

At the same time, if we remove commodities and add the 5% allocation back into the S&P 500, we extended the data to 1999 AND see that the greater diversification paid off.

60/40 diversification

Of course, this time period saw the tech bubble burst, 9/11 and the Great Recession, all of which had significant affects on the S&P 500. And that really is the point. While diversification is generally a sound approach to investing, it’s not a guarantee of higher returns.

Final Thoughts

The 60/40 portfolio is certainly not the only reasonable approach to investing in retirement. Yet for many retirees, it has stood the test of time. It offers both growth and stability, which retirees need for their money to last 30 years or more.

Nobody knows the future. Is it possible that we could see unprecedented economic conditions that could wreck havoc on retirees? Of course we could. Although if that happens, one wonders if any asset allocation would save us.

How Much Cash Should Retirees Keep On Hand?

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Moving from a regular paycheck to living off of your nest egg is not an easy transition. At least it hasn’t been for me. One of the many decisions retirees must make is how much cash should they have in the bank.

For some it’s a question of budgeting. They keep enough to pay the bills over the next several months, but that’s it. For others cash acts as a buffer in the event the stock market drops 10%, 20% or more. For those who see cash as a buffer, several more questions need to be considered:

  • How much cash should you keep in the bank?
  • How do you decide when to replenish your spending account?
  • Do you factor the amount of cash you have into your overall asset allocation?

In this article I’ll explore these questions. We’ll look at some research papers that address these questions. We’ll also talk about how you can get the psychological benefits of holding lots of cash without actually holding lots of cash.

The starting for all of this is the 4% Rule. First, however, we need to cover the basics.

Table of contents

What is Cash?

For our purposes, I define cash as money in an FDIC-insured account (checking, savings, money market account or possibly a certificate of deposit) or a money market fund. The later is not FDIC-insured, but it’s extremely safe.

What I don’t include in cash are bonds. That’s true even for short-term U.S. government bonds. T-bills as they are called are extremely safe. But they aren’t cash. And even a short-term bond fund can lose money when interest rates rise.

What about Social Security, Pensions, Annuities, and Part-Time Work?

Retirees fund retirement from many sources. Most receive social security. Many have pensions or annuities. And some, myself included, still do part-time work to generate some income. All of these sources generate cash for us, typically on a monthly basis.

The question we are addressing is how much cash, over and above any cash these other sources generate, do we need to pull from our investments. In other words, how much do we need to pull from 401k, IRA and taxable accounts each month or year for living expenses.

These other sources will of course reduce how much we have to pull from our investments. But most of us have to pull something out, and that’s what this article addresses.

The Budget-Dividend Strategy (My Preferred Approach)

My preferred approach to cash in retirement is what I call the Budget-Dividend Strategy. The nice thing about this approach is that it addresses three liquidity concerns at the same time:

  1. It guarantees that I’ll always have cash on hand
  2. It helps with budgeting
  3. And it coincides with quarterly dividend payments, which can be used as a source of funds

Here’s how the Budget-Dividend Strategy works.

At the start of the year I pull six months worth of living expenses from our investment accounts. In our case the money gets deposited into our checking account.

When the balance declines to three months of living expenses, we add cash to bring the balance back to the six months of expenses level. If we are generally on track with our budget, this should happen after three months.

The timing is convenient because ETFs and mutual funds typically pay dividends at the end of each quarter. In our taxable account, we do not automatically reinvest dividends. So once the dividends hit our money market fund in our brokerage account, I can move some or all of them over to our bank account.

If we need more than the dividends give us, I withdrawal additional funds from investment accounts. Here I make the decision on a number of factors, such as taxes and which asset classes have performed best.

Once we start taking Required Minimum Distributions (still two decades away), we’ll use the RMD to fund living expenses as well.

Benefits of the Budget-Dividend Strategy

The are several benefits to this approach.

First, we keep the vast majority of our capital fully invested. Even assuming an initial 4% distribution per year, we never have more than 2% in cash (6 months of living expenses). And this number drops to 1% (3 months of living expenses) before we replenish the cash account.

Second, the timing of when we replenish the account coincides with distributions from ETFs and mutual funds. This isn’t necessary, and may be irrelevant for those without significant taxable investments. But it’s convenient for us.

Third, the approach also makes budgeting easier. We track our spending in Personal Capital and Tiller Money. This approach to cash, however, makes it easy to know at a glance if we are on track, over spending or under spending.

The No Cash Strategy

One approach to cash in retirement is virtually no cash at all. One could sell investments monthly to cover just one month of expenses. If most spending is put on a credit card, the no cash strategy could work.

Personally, I find the idea of tapping my investments monthly to be too much of nuisance. Still, it’s worth pointing out that one could take this approach. For those who do, finding a broker that offers check writing, online bill pay, and perhaps even a debit card would be useful. Even here, however, you’d be transferring funds from stock and bond funds to a money market fund every 30 days, which many would find tiresome.

The Buffer Strategy

Our approach to cash keeps the vast majority of our assets fully invested. Some advocate a different approach called the Buffer Strategy. The idea is to keep as much as five years worth of living expenses in cash. The strategy has some initial appeal.

Over the past 100 years, the worst stock market performance saw a decline four years in a row (from 1929 to 1932). The market has never been down five years in a row.

Here’s a chart of the S&P 500’s yearly performance dating back to 1928:

S&P 500 performance by year from 1928 to 2021

Of course the market could be down 5 years in a row sometime in the future. But the idea of a cash cushion is to avoid selling stocks when the market is down. It has some intuitive appeal.

And it’s a bad strategy.

First, if we rebalance our portfolio at least once a year, we won’t sell stocks in a bear market. When the market is down significantly, the simple act of rebalancing will cause us to sell bonds and buy stocks. This is true even if bonds decline a bit.

For example, in 1931 the 10-year Treasury Bond was down 2.56%. The S&P 500 (or equivalent) was down more than 43%! In that scenario, we still be selling bonds to buy stocks as part of rebalancing.

Just as important, holding five years worth of cash creates a serious drag on our portfolio’s performance. Let’s make sure we understand why.

Cash and the 4% Rule

The 4% Rule comes from a 1994 paper written by financial planner Bill Bengen. Using historical returns and inflation data, Bengen tried to answer how much a retiree could spend each year without going broke.

His conclusion was that a retiree could spend 4% of his or her nest egg in the first year of retirement. Thereafter, they could increase this amount by the rate of inflation (he used CPI). Following this approach, he concluded, a retiree’s nest egg would last at least 30 years, and in some cases 50 years or longer.

There were, however, some important underlying assumptions in his work. For example, he assumed retirees invested in an S&P 500 index fund for stocks and an intermediate U.S. government bond fund for bonds. He also concluded that stocks should represent 50 to 75% of a retiree’s asset allocation. Any more and a big stock market decline (e.g., 1929 to 1932) would shorten the longevity of a portfolio. Any less and a return to double-digit inflation could do irreparable harm.

So what does this have to do with how much cash we should hold?

For his analysis, Bengen assumed that retiree withdrew funds from the portfolio once a year and then rebalanced. The rebalancing did not factor in the cash that was just taken from the portfolio. His focus was not on how much cash to hold. That’s just the approach he chose for his analysis.

Nevertheless, it’s important to keep his approach in mind. For those choosing to deviate from a once-a-year distribution strategy (at most) to hold significantly more cash, keep in mind that the conclusions from his research may not hold. And indeed, subsequent research confirms this outcome.

Research on the Buffer Strategy

Arguably the most comprehensive study comes from Professor Walter Woerheide, Ph.D., ChFC, CFP®. At the time of publication, he was the Frank M. Engle Distinguished Chair in Economic Security Research, at The American College in Bryn Mawr, Pennsylvania.

In 2012 Professor Woerheide published a paper entitled, Sustainable Withdrawal rates: The Historical Evidence on Buffer Zone Strategies. He evaluated cash buffers of one to four years, using a replenishing strategy based on whether the investment portfolio was up or down the previous years.

If the investments were up, the cash buffer was replenished along with any required withdrawals. If the portfolio was down, withdrawals came from the cash buffer. The only time cash came from the investment portfolio following a down market was if the cash buffer were exhausted.

Looking at several different asset allocations, the results were clear. A cash buffer strategy underperforms a standard rebalancing approach. It reduces the likelihood that a portfolio will last 30 years. It also reduces the portfolio’s balance at death.

Here’s a summary of his findings:

Cash Buffer and Sustainable Withdrawal Rates

Several other studies have confirmed these results:

Harold Evensky

Harold Evensky is the father of the bucket strategy. He’s also a proponent of the Buffer Strategy for cash. In 2021 he co-authored a paper (The Benefits of a Cash Reserve Strategy in Retirement Distribution Planning) that concluded a cash buffer equal to one year of expenses actually improved the likelihood that a portfolio could be sustained for at least 30 years. His study is the outlier and deserves a brief comment.

He found the a 1-year buffer strategy (he called it the Cash Flow Reserve or CFR) out performed a standard rebalancing approach (RDCA–Reverse Dollar Cost Averaging), particularly with taxes and transaction costs were factored in. Here’s a summary of his findings:

Survival Rates for Cash Buffer Strategy

There are several serious flaws in the study.

First, it used a 1-year cash buffer that was allowed to fall to just two months. As a practical matter, that’s no cash buffer at all.

Second, he used a Monte Carlo simulations instead of historical data. In and of itself this isn’t a problem, but the inputs he used heavily favored cash. He assumed an average stock return of 8.75%, well below the historical average. He also assumed a 3.5% return on cash with a 3.0% rate of inflation. This gave cash a 0.50% real return.

In other words, the study was designed to reach a certain conclusion, in my opinion. The fact is that a significant cash cushion represents a significant drag on performance that hurts retirees in the long run.

How to Sleep at Night with Little Cash in the Bank

While it’s clear that the Buffer Strategy underperforms, we need to address the psychology factors. As someone who is semi-retired, I understand firsthand the fear of spending investments. That fear grows when the stock market drops as it did at the start of the Covid pandemic.

To address this real concern, here are a few approaches retirees can take that won’t do as much harm as holding too much cash.

First, calculate how long you can live on just your bonds. If you have a 60/40 stock/bonds allocation, for example, you can live on just the bonds for about 10 years, assuming an initial 4% withdrawal.

This approach assumes your bonds are primarily U.S. government short and intermediate-term bonds. Riskier bonds, such as high-yield or emerging market debt might not provide as much comfort. The point is that recolonizing just how long your bond portfolio can get you may help you weather a stock market decline.

Second, and related to the first, is to allocate some of your bonds to cash. For most this would mean a money market fund. For example, a 60/40 portfolio would become a 60/30/10 portfolio (stocks/bonds/cash). Studies have found that converting some of the bonds to cash doesn’t have a major effect on the longevity of the portfolio.

Bill Bengen actually reached this conclusion in a 1997 paper. He found that a 10% allocation to short-term U.S. Treasury Bills did not significantly reduce the starting safe withdrawal rate of about 4%. Others have reached similar conclusions (see here and here).

Final Thoughts

Investing during retirement can be stressful. Still, we need to resist the urge to play it “safe” by holding too much cash. What may feel safe could over time do far more harm than good. A simple approach of three to six months in cash keeps are capital invested while still giving us ample room to do with unexpected expenses.

How Investment Fees Affect Wealth

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It costs money to invest. We pay all types of fees, some obvious, some not so obvious. In this article I’m going to walk through the most common investing fees you are likely to encounter. Then we’ll examine just how destructive a seemingly small amount of fees can be to your wealth and retirement.

Table of contents

Do Fees Really Matter?

Before looking at specific types of investment fees, let’s first ask whether fees really matter. To answer that question, the first thing we must recognize is that seemingly small fees, over time, can seriously reduce the value of an investment portfolio.

The Securities and Exchange Commission (SEC) published a paper on this very topic in 2014. It noted that “fees may seem small, but over time they can have a major impact on your investment portfolio.”

Invest fees affect on a portfolio over 20 years

Some have argued that fees don’t matter. Instead, what matters are returns after factoring in the fees. In other words, paying high fees is not only fine, but ideal, if the investment returns enough to justify the fees. Conceptually this makes sense. In practice, however, it falls apart.

Study after study after study shows that expensive investments underperform inexpensive investments. For example, Vanguard looked at the annualized returns for a 10 year period ending December 31, 2014 for two groups of mutual funds: 25% of the funds with the lowest expense ratio and 25% with the highest. The low-cost funds won.

Funds with lower costs outperform more expense ones

The primary way we keep fees down, as we’ll discuss more below, is to use low-cost index ETFs and mutual funds. It’s an approach Warren Buffett, the CEO of Berkshire Hathaway and arguable the best investor alive today, supports:

Nevertheless, both individuals and institutions will constantly be urged to be active by those who profit from giving advice or effecting transactions. The resulting frictional costs can be huge and, for investors in aggregate, devoid of benefit. So ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.

My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. . . . My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.

Types of Investment Fees

There are countless fees investors may encounter. I’m going to list them in the order you are more likely to encounter them. Some fees are virtually unavoidable, but can be kept to a minimum. Other fees should be avoided at virtually all costs. Frankly, the only fee that is truly unavoidable is the first one on our list–expense ratio.

Expense Ratio

Mutual funds and ETFs charge investors a fee. The fee covers the cost of the fund, including payroll, as well as profit for the fund company. Expense ratios are expressed as a percentage. For example, a fund that charges a one percent (1%) expense ratio would cost an investor 1% of the amount invested in the fund (e.g., $100,000 investment would cost $1,000 per year with a 1% expense ratio).

The expense ratio is practically unavoidable. Fidelity does offer a few funds with no expense ratio, but that’s the exception. Even low-cost fund provider Vanguard charges expense ratios on its ETFs and mutual funds.

Transaction Costs

There can be costs to buy and sell stocks, mutual funds and ETFs. By and large these costs are easy to avoid. Most mutual fund companies and brokers have gone to $0 trades if made online. There is, however, one important exception.

Many brokers charge a commission when you purchase a mutual fund (not an ETF). For example, I have an account at Merrill Edge, and the broker charges $19.95 when I purchase certain mutual funds. They do have a list of fee-free funds, but many of the funds I use from Vanguard would require payment of the commission.

For this reason, it’s important to understand the types of investments you want to make before choosing a broker. If you know, for example, that you’ll invest entirely in Vanguard funds, it makes sense to open an account at Vanguard or a broker that offers at a minimum free Vanguard ETFs. M1 Finance is a good example and a broker I also use.

Investment Advisor Fees

Advisor fees come in two forms: (1) a percentage of assets under management (AUM), or (2) a fixed or hourly fee. The vast majority of advisors charge a percentage of AUM, with 1% the industry standard (although fees do vary based on account size and services provided).

Some lower cost AUM advisors have entered the market over the past 10 years or so. Vanguard offers advisory services for just 30 basis points. A number of so called robo-advisors offer their services for about 25 basis points (e.g., Betterment and Wealthfront).

A growing list of advisors have turned to hourly or fixed fees. These arrangements almost always favor the client, as the total cost is generally far less than the AUM model. One such advisor is Mark Zoril of PlanVision.

As you’ll see in a minute, Advisor fees based on a percentage of AUM destroy more wealth than any other fee (although high expense ratios are a close second).

Load Fees

Some mutual funds charge what are called load fees. Front-end load fees are paid when you invest in a mutual fund with this type of fee; Back-end load fees when you sell.

Front-end load fees typically cost 5.75%. For every $100 invested, fees take $5.75, leaving $94.25 in your account. There’s absolutely no reason to invest in mutual funds that charge load fees. Ever!

Where to Find the Expense Ratio of a Mutual Fund

There are several easy ways to find the expense ratio of any mutual fund or ETF. For starts, you can Google the ticker symbol of the fund. VSTAX, for example, is Vanguards total stock market fund. Searching “VSTAX” returns the following result, including the fund’s expense ratio:

How to find expense ratio using Google
(The Expense Ratio of 0.04% is in the bottom right of the image)

You can also see if a fund charges a load fee AGTHX, an American Funds growth fund:

how to find load fees
Note the “Front load” of 5.75%

Another free tool that tracks both the expense ratio as well as any load fees is Morningstar. You can also check the prospectus of the funed.

As for investment advisor fees, you should ask. It’s as simple as that. It should also be reflected on your statements. You can also find fee disclosures in the advisor’s Form ADV. But asking is much easier.

How to Determine the Expense Ratio of Your Investment Portfolio

While it’s important to know the expense ratio of each investment, what really matters is the overall expense ratio of your portfolio. You could calculate this by hand. Just take the weighted average of your expense ratios across all of your investments. If that sounds as inviting as a root canal, there is an easier way. Use Personal Capital.

Personal Capital is a free financial dashboard. Link all your financial accounts (checking, savings, credit cards, retirement accounts, HSAs, loans, taxable investments) and Personal Capital provides a wealth of tools. You can do everything from budgeting to loan payoff to retirement planning. And for our purposes, it will automatically calculate the expense ratio of your investment portfolio.

Here’s the results from a demo portfolio I entered into Personal Capital:

Note the 0.10% annual fee to the right. That’s the expense ratio of a portfolio that included dozens of investments. You can read my review of Personal Capital or go directly to its free signup page (truly free-no credit card needed–ever).

How Fees Affect Your Wealth

Let’s imagine that we make the maximum contribution to an IRA ($6,000) during our working years from age 20 to 65. If we earn an average of a 9% return on our investments, we’ll retire with about $3.1 million (gotta love compounding).

Now let’s assume we pay an investment advisor a “small” 1% fee. Our retirement fund drops to $2.3 million. Add in a 1% expense ratio on the mutual funds, and our nest egg falls further to $1.7 million. Yeah, fees matter.

How to Avoid Most Investment Fees

There are several important steps to take to keep you fees low.

Low cost index funds: First, stick to low cost index funds (ETFs or mutual funds). They outperform the vast majority of actively managed funds over time. There are plenty of sound “lazy portfolios” that make for great long-term investment strategies. Here are a few of them:

Avoid Expensive Advisors: There’s simply no good reason to pay more than about 0.30% of AUM, at the most. Vanguard offers its services at this price. Why pay more? And there are plenty of advisors who charged by the hour, which is even better.

Consider Automated Investment Services: For those that want a little help, you can consider a robo advisor. They come in all shapes and sizes. I like Betterment and Wealthfront for those who want a set-it-and-forget-it arrangement. Cost is about 25 basis points. For those who want more control, M1 Finance is the way to go. It lets you create your own mutual fund (they call them Pies). It’s easy to use, easy to rebalance, and free.

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