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I recently posted an article called Portfolio Insurance on how to re-sequence a bad sequence of returns into a better sequence by holding some cash (2 years of planned annual withdrawal) in a risk free account.
You re-sequence by rebalancing and living off the cash while the market recovers.
It’s a relatively cheap insurance hack.
This article is another relatively cheap but powerful hack by creating a second retirement (called the Life Boat) to have handy if the first retirement fails.
I consider a retirement portfolio to be a product you purchase during the course of your working life.
The purpose of the product is to safely replace your working income in retirement.
The problem with “safe retirement” is risk.
You can manage risk by having a big pile, by taking out a small amount, by having an extra income source like an annuity, pension, or social security, and getting lucky with a good SORR [Sequence of Return Risk].
Another method of insurance is to have a spare retirement sitting around in case the first fails.
The trick to this is to start early put some money away in an account you don’t access even after you retire (leaving it closed to SORR) and just let it compound for a very long time.
The main retirement should be big enough to carry you on your trip into the future.
It typically takes decades for a mistake to show up, and by the time decades happens you will likely be too old to fix things.
So a life boat is your insurance to reach the end of your journey and not die poor.
A life boat is not that expensive.
Below is an example of a saver who started building his life boat at age 30.
- He puts $8K away each year for as long as he works.
- Upon retirement (age 50) he stops contributing and just lets the what’s in the account grow unmolested, re-balancing each year or two.
- I would use a 60/40 mix of VBMFX [Vanguard Total Bond Market Index Fund] and VTSMX [Vanguard Total Stock Market Index Fund]and no other extra funds. This mix has good risk, good return, it lives on the efficient frontier and has very low portfolio cost.
- Rebalancing every 2 years allows for proper risk management over decades of upturns and downturns.
Here is a table of the lifeboat:
Lifeboat Portfolio
| Age | Contribution | Principal | Value (6% interest) | Age In Retirement | Lifeboat Value |
|---|---|---|---|---|---|
| 30 | $8000 | $8000 | - | 50 | $337,599 |
| 31 | $8000 | $16,000 | $16,960 | 51 | $357,855 |
| 32 | $8000 | $24,000 | $26,458 | 52 | $379,326 |
| 33 | $8000 | $32,000 | $36,525 | 53 | $402,086 |
| 34 | $8000 | $40,000 | $47,197 | 54 | $426,211 |
| 35 | $8000 | $48,000 | $58,508 | 55 | $451,784 |
| 36 | $8000 | $56,000 | $70,499 | 56 | $478,891 |
| 37 | $8000 | $64,000 | $83,209 | 57 | $507,624 |
| 38 | $8000 | $72,000 | $96,681 | 58 | $538,082 |
| 39 | $8000 | $80,000 | $110,962 | 59 | $570,366 |
| 40 | $8000 | $88,000 | $126,100 | 60 | $604,588 |
| 41 | $8000 | $96,000 | $142,146 | 61 | $640,864 |
| 42 | $8000 | $104,000 | $159,155 | 62 | $679,316 |
| 43 | $8000 | $112,000 | $177,184 | 63 | $720,074 |
| 44 | $8000 | $120,000 | $196,295 | 64 | $763,279 |
| 45 | $8000 | $128,000 | $216,553 | 65 | $809,076 |
| 46 | $8000 | $136,000 | $238,026 | 66 | $857,620 |
| 47 | $8000 | $144,000 | $260,787 | 67 | $909,077 |
| 48 | $8000 | $152,000 | $284,915 | 68 | $963,622 |
| 49 | $8000 | $160,000 | $310,490 | 69 | $1,021,439 |
| 50 | $8000 | $168,000 | $337,599 | 70 | $1,082,726 |
| 51 | $8000 | $176,000 | $366,335 | 71 | $1,147,689 |
| 52 | $8000 | $184,000 | $396,795 | 72 | $1,216,551 |
| 53 | $8000 | $192,000 | $429,083 | 73 | $1,289,544 |
| 54 | $8000 | $200,000 | $463,308 | 74 | $1,366,916 |
| 55 | $8000 | $208,000 | $499,586 | 75 | $1,448,931 |
| 56 | $8000 | $216,000 | $538,041 | 76 | $1,535,867 |
| 57 | $8000 | $224,000 | $578,804 | 77 | $1,628,019 |
| 58 | $8000 | $232,000 | $622,012 | 78 | $1,725,700 |
| 59 | $8000 | $240,000 | $667,813 | 79 | $1,829,242 |
| 60 | $8000 | $248,000 | $716,361 | 80 | $1,938,997 |
| 61 | $8000 | $256,000 | $767,823 | 81 | $2,055,337 |
So for an investment of $168,000 over 20 years (from ages 30 to50), by age 81 (31 years in the future from age 50) you will have an extra $2M available.
If the SORR or too aggressive of a withdrawal rate kills your main portfolio, your lifeboat brings you on home.
If you didn’t start at age 30 you can figure your catch-up requirement or build a smaller life boat.
You do not want to be caught with your pants down when the market turns.
“Only when the tide goes out do you discover who’s been swimming naked”- Warren Buffet
By implementing a combination of the SORR re-sequencing asset strategy and the lifeboat portfolio strategy you in effect are wearing both a belt and suspenders to make sure this doesn’t happen
This works because it serializes your exposure to SORR.
Only one retirement portfolio at a time is exposed.
Anchors Aweigh my friends. Fair Winds and Following Seas on your journey. (I’m an ex Navy Doc)
Again I would like to thank Gasem for contributing another great post for my readers.
Hopefully now you will not get caught with your pants down and not die poor.
(And please don’t forget to subscribe to this blog so you do not miss a single post)
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Nobody likes being caught with their pants down ?
What I am a little confused about is why the lifeboat just started at $370k? I get the $8,000 contribution but not sure where that starting money comes from at age 30?
TPP
And, the website didn’t go through.
Thanks for letting me know. I will fix it.
Hey TPP. I let Gasem know that there are questions so hopefully he will answer.
The way the table is set up, it is not a starting value of the lifeboat at $370k. Basically if you contribute $8k/yr at age 30, if you retire at 50 it is worth $337k, age 51 it would be worth $357k, etc (the last column is the value of the lifeboat after X amount of years of contribution if you started investing at age 30). I hope that answers your question.
It’s a formatting issue. Like XRAY said the 357k is what you have saved and compounded by age 51 when no more contributions occur. After that the portfolio just grows on it’s own
Interesting idea. However, would you still recommend doing a lifeboat strategy if your principle investments were passive index funds and essentially the same investments, and you didn’t plan to withdraw them early? Is this more of a strategy if you are engaged in other active investments or more prone to make mistakes trying to time the market before retirment?
Thanks Financial Verdict for the comment. I sent an email to Gasem so hopefully he will explain it in better detail.
My take on it is that you want to have a more conservative portfolio compartmentalized from your main portfolio. The question you pose is if the main portfolio is just as conservative as the lifeboat portfolio do you really need to have it compartmentalized (if the holdings in both are exactly the same). My guess is that in this situation it is probably unnecessary (again hope Gasem will elucidate us more on the subject)
In retirement the portfolio is assaulted on several fronts. Taxes, overspending, market risk, long crashes, unexpected illness, even deflation. The point is you make a projection (4 x 25) and then run an experiment for 30 years and ask was your plan a success or failure? Once you get 20 years into a 30 year plan you’re already screwed and it becomes very difficult to turn the ship. By having assets unexposed to taxes, SORR, over spending etc you have somewhere to go with your expenses. So that is the difference. It’s not the assets per se’ that are at… Read more »
I enjoyed the Gasem post, as always. It seems like a novel take on the popular “Three Bucket Strategy”, deploying Bucket 1 (cash) for emergency and lousy market conditions, Bucket 2 (Growth and Income, 60/40) for long term failure insurance, and Bucket 3 the core retirement portfolio. For some of us, it’s too late in the game to start the $8000 per year to set aside to make a difference, but we could do the following. 10% Cash for SORR and emergency 10% 60/40 portfolio and other than double secret emergencies and rebalancing, forget about it. 80% Core retirement portfolio… Read more »
Thanks VagabondMD for the comment. You are right, I was thinking this would have been great to start doing right from residency. 17 years later it is hard to take as much advantage of time as it would have been back then.
That is a pretty good suggestion for the “late bloomers” like us.
For those a lot closer to retirement you loose the advantage of decades of unmolested compounding. If you look at 20 years @ 8k per year you only have 357K saved, but at 80 years that turns into a whole lot of moolah. This strategy levers compounding but in order to make it really pay you have to start young. But then again every year there is a new crop that comes out and has the propensity to start young, and for a relatively small donation it can pay big in end of life flexibility for a family. An extra… Read more »
Very nice concept. I think I kinda sorta did this in my 30s. I DCA about 5k /month into a couple of mutual funds for years. I also saved into retirement accounts and saved money for individual stocks. Any way the money just left alone in mutual funds is very large now. It is not ideally invested (American funds) but it is better than a sharp stick in the eye as Vagabond would say. I have short term money and a nice muni bond position.. My defense against SORR is a big pile with low spending.
You definitely are head of the curve in so many ways Hatton 🙂 I had invested (thankfully not much) in American funds when I was in residency on the advice of a financial advisor. Since the money was not that much, when I saw the light I converted to vanguard index funds.
You my dear Hatton1 as usual are proof of concept! It’s so interesting that some of us older FI types me, you, Vagabond, DrMB, made our individual piles in a somewhat different way than the typical Bogelhead format and have different takes on return and risk management. Bravo on your foresight. I’ve been doing a lot of study on the neurological and neuropsychological basis of risk and reward behavior. Seeking reward it turns out is controlled by very different structures than avoiding risk, and the structures are neurobiologically much older than the cortex, so they inexert their influence in a… Read more »
Thanks for the great post Gasem. It always amazes me what time and compounding can do. I actually have started Roth IRA’s for my daughters and just put it in those two funds and an total international fund. Wish I had started the same thing in my 30’s . Then I would have had a large lifeboat by my age instead of just a life jacket.
Your daughters are very lucky that you have given them a head start in ROTH contributions (does this mean that they have been employed so that they can contribute?). I am going to do the same when my daughter starts working (shes only 12 right now though).
Yes a Roth started early enough is amazing. The lack of tax consequence is the gift that keeps on giving. Strong work VP! I do the same with the 2 fund portfolio. I don’t buy that “international” buys you anything but more risk in the long run.
As always, great post by Gasem. In a sense, I am sort of doing this. I have my own set of tax-advantaged retirement accounts and my wife has her own set too. We have a joint taxable account with Vanguard with a mix of VTSMX and VBMFX. It’s not quite 60/40 right now, but we can add additional funds to balance it appropriately. It’s a joint account that we plan to add to every year without touching it. The past two years we have added about $10k a year. Since I’m 35 now, I think it would be close to… Read more »
That is awesome DMF that you were essentially doing something like this all along. I wish I had Gasem mentor me about 17 years ago. 🙂
Yes. Having more senior statesmen like you, Gasem, Vagabond, Hatton, WCI, PoF, et al. is so wonderful for us youngsters like me and TPP!
Having all of you as mentors (is what I meant) 🙂
Not sure I’d call myself a statesman, more like a bomb thrower. I just want to see everyone do well
Yes, perhaps bomb thrower is more appropriate. LOL! ?
I think I just became a senior statesman. Ha
I love reading stuff from Gasem. I came by all this very differently. I barely invested in equities until May 2018. I am building a 3 fund portfolio only because I live in the International portion. I never heard of WCI, never heard of Bogleheads until earlier this year. I never even heard of SORR until this year. I was more into real estate and just saving. I think I got less than a 1% return. And we will all get to the promise land I assure you. I am seeing that it is the unrelenting mission of us all… Read more »
Thanks DMB for the wonderful comment. You have done supremely well in your portfolio management proving what Dr. Dahle says on White coat that, “there are many roads to Dublin.”
There are many ways to mitigate risk and Gasem has provided multiple great examples how to do so.
One great thing about cash is you can spend it if the need arises! Doesn’t horrify me in the least. I call it a form of risk management. Tnx DMB
Love the idea of the lifeboat strategy Gasem! Another great post. My question is, would you recommend contributing to a lifeboat strategy, after a certain retirement contribution threshold.
So for example, say you max out 401K, should the next bucket be a Roth IRA vs this separate nest egg (lifeboat).
Or are you basically saying it doesn’t really matter what account it is put in, Taxable, Roth etc, as long as it is treated in retirement as the lifeboat? Meaning not drawing down on the account as recommended in the strategy
Hey TJ, The “separation of funds” is somewhat artificial. You accomplish the same goal by reducing WR, which means a bigger starting retirement nut. I’m sure you know something about Monte Carlo analysis given your profession, the extra money just places your safety factor farther into the tail of the distribution.
Enjoy the contrarian thinking as always. I can appreciate having a backup umbrella in case my first leaks, and while I’m beyond the age of using this strategy, I’ll certainly highlight it to the younger folks who are fresh out of residency and place a premium on risk aversion. Well executed, Gasem.
Thanks for stopping by CD. This is another strategy that favors the youth by taking advantage of time. Hopefully some of the younger folks don’t blow an amazing opportunity to set themselves up in future
Thanks CD, Homey likes him some compounding, and a few thousand a year even if paying off loans is do-able. Personally I don’t believe in paying loans unless they are more expensive than market return. If more expensive than market return like CC debt, pay them sucka’s. You may eliminate a decade of compounding screwing around with a 4% loan and missing 4% return. Dave Ramsey is for people who have hosed up their lives with debt. If your debt is rational (like 250K on a 5 million dollar career) then repayment can also be rational. But then I am… Read more »
I certainly look forward to having my pants up by preparing now for any tough situations!
A pantsless Duke would probably raise some high society eye-brows. Although some of the antics of the England princes may make it more tolerable these days 🙂 Glad to have the royal visit here. Thanks
My approach is belt, suspenders or belt and suspenders. Choose your level of risk Tnx Chris
Great post! Really inspiring and thought provoking for me. I like the lifeboat strategy idea a lot.
Thanks Andrea. Gasem definitely is one of those individuals that has such a great analytical mind and shows you ways to think outside of the box.
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