Eva is on the brink of financial independence, but she is concerned about making the transition smoothly. How can she prepare her portfolio for success during the early retirement drawdown years? In today's episode, former financial planner Joe Saul-Sehy and I examine this topic in detail.
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Eva inquires (at 03:10 minutes): How should someone close to financial independence (FI) begin the shift from accumulation to decumulation, and what role do concepts such as the efficient frontier or risk parity models play in that process? I met both of you at the Purpose Code book launch in New York last December, and a question that surfaced during the Q&A has lingered in my mind. Someone mentioned sequence of returns risk, which got me contemplating how to manage finances as one approaches FI.
I suspect many long-time listeners find themselves in a similar position—we’ve been working towards FI for years, and after a largely favorable market period, we are nearing our objectives. So, when and how should we adjust our portfolios as we transition from accumulation to drawdown?
Two concepts frequently arise in my research. The first is the efficient frontier, which you have recently discussed—the notion that risk can be reduced while still maintaining returns by optimizing portfolio design. The second is risk parity, specifically tailored for decumulation. Frank Vasquez has delved into this on his Risk Parity Radio podcast, but I'm eager to hear your perspective since I don’t believe you have fully explored it yet.
It appears that these two strategies could complement one another. For instance, models like the Golden Ratio propose a sustainable withdrawal rate of 5 percent, which may alter how someone determines their FI number. I’m interested in your views on how we should approach asset allocation, portfolio complexity, and individual risk tolerance as we get ready for decumulation—particularly for those aiming for early retirement or a lifestyle free from work.
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Summary of Our Response:
After years of building your retirement savings, the transition to the withdrawal phase can be daunting. Former financial advisor Joe Saul-Sehy joins us to address what he describes as “the hardest part of financial planning.”
Joe points out that retirement withdrawals necessitate a different outlook compared to accumulation. While many focus on straightforward “safe withdrawal rates,” Joe advocates for a more organized approach utilizing a four-bucket strategy:
- Lumpy spending bucket – Funds allocated for significant expenses in early retirement (like travel or home improvements), designed to be spent down to zero.
- Short-term bucket – Cash reserved for two to three years' worth of expenses.
- Mid-term bucket – Investments for years 3-10 in moderately conservative options.
- Long-term bucket – Growth-oriented investments meant for 10+ years.
This strategy forms what Joe refers to as “a personalized target date fund,” where you regularly rebalance by reallocating funds from the long-term to mid-term bucket, and from mid-term to cash.
“The biggest hurdle I’ve ever faced is you,” Joe remarks, emphasizing that behavior—rather than market downturns—often disrupts retirement plans. A clear bucket strategy reduces the likelihood of panicking during market declines, as you comprehend the reasoning behind your allocation choices.
Joe also stresses the necessity of preparing for “tax roadblocks” such as Required Minimum Distributions and Medicare IRMAA surcharges, suggesting that you start transitioning your portfolio approximately 10 years before retirement.
In conclusion, Joe advises beginning with your aspirations rather than reverse-engineering from withdrawal rates: “Start with the Great Barrier Reef, start with Machu Picchu”—determine what you want in retirement, then create your financial strategy to support those goals.
Resources Referenced:
- The Efficient Frontier Was Perfect Until HR Got Involved
- Practical Investing and the Efficient Frontier with Joe Saul-Sehy
- Ask Paula: How To Optimize Your Investments Along the Efficient Frontier – If You Dare
- Interview with Bob Elliot
- Interview with Polina Marinova Pompliano
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Eva is nearing financial independence, but she is concerned about potentially making mistakes during this transition. What strategies can she implement to ensure her portfolio is well-prepared for the drawdown phase of early retirement?