Before You Choose Investments for Retirement, Decide What Each Dollar Is For

As retirement gets close, the questions start piling up. How much should be in bonds? What withdrawal rate makes sense? Should an annuity be part of the plan? How much cash is enough?

Those are fair questions, and each one deserves an answer eventually. There's one I'd want answered first, though, because it shapes how all the others get answered.

What does this money need to do for you?

Put another way, what life do you want retirement to make possible, and how can the resources you've built best support it?

Once the paycheck stops, your savings and investments usually take on several different responsibilities. Giving your money a defined purpose before deciding how to invest it helps connect those decisions to the life you're trying to support.

One pool of money becomes several assignments

While you're still earning a paycheck, it's natural to think of your retirement savings as one big pool. You contribute, you invest, and the goal is mostly to help it grow.

Retirement changes the assignment. Those accumulated resources now have to support the life you saved for, and that support can take several forms.

• Income for the rest of your life. Your investments may need to supplement Social Security, pensions, or other income sources for several decades.
• Income for a surviving spouse. If you're married, the plan needs to account for what happens when one spouse dies and benefits, taxes, and household expenses change.
• Money for emergencies. Things like a major home repair, an unexpected medical bill, or replacing a vehicle.
• Resources for larger financial shocks. An extended care need or ongoing financial support for a family member can create obligations that last for years.
• Money you want to leave behind. If leaving something to family or charity is important to you, those resources need to be considered alongside your lifetime spending.

That's a lot to ask of one pool of money.

A single portfolio can sometimes carry several of these responsibilities. The question I'd want answered is whether the same dollars are being asked to handle several obligations at once without anyone noticing.

That's where problems can develop. Money that looks available on an account statement may already be needed somewhere else in the plan.

Money you can reach versus money that's already spoken for

A hypothetical example makes this easier to understand. To keep it simple, we'll ignore taxes, investment returns, fees, and inflation. We'll also assume the investments can be sold readily and that the unexpected expense occurs before the next annual withdrawal.

Say a couple retires with a $1 million investment portfolio. Based on their other income and what they plan to spend, they're counting on that portfolio to provide $40,000 a year.

That's 4% of their starting portfolio.

Now imagine something major happens shortly after retirement, and they need $250,000.

They can access the money. They sell $250,000 of investments and cover the expense.

But now their portfolio is down to $750,000, and they're still asking it to provide the same $40,000 every year.

Their annual withdrawal went from 4% of the portfolio to a little over 5.3%, even though the amount they need to spend hasn't changed.

That higher percentage alone doesn't establish whether their retirement plan will succeed or fail. It shows how a major expense can increase the demands on the assets that remain.

The $250,000 was available in the sense that they could reach it. But those dollars were already helping support another obligation.

That distinction is one of the most useful in retirement planning.

If someone tells me they have $1 million available for retirement income, emergencies, future care, and an inheritance, I don't read that as $1 million assigned to each responsibility. It's one million dollars with several competing demands on it.

A useful test is to ask whether the rest of the financial plan would still hold together if a particular pool of money disappeared tomorrow.

If removing it would lower the income the plan can support, those dollars already have a job.

An emergency reserve should be money that can be removed from the plan while leaving the household's intended lifestyle adequately funded. The money also needs to be accessible on reasonable terms when it's needed.

Once you understand that distinction, you can start deciding which resources should be responsible for which obligations.

Giving your money a job doesn't mean opening five accounts

Organizing money by purpose doesn't mean you need five different investment accounts.

Several jobs can exist within the same account. What helps is knowing the assignment for each portion of your money so one balance isn't counted in full toward several obligations at the same time.

For example, you might have investments intended to support withdrawals over the next few years alongside other investments you don't expect to need for another twenty years. They could be held in the same account, but those dollars have very different assignments.

Once I know what a dollar is supposed to accomplish, much better questions open up.

• When will you need it?
• How much access do you need?
• How much can its value move before that creates a problem?
• Does it need to produce dependable income?
• How long does it have to grow?
• If you spend it, what happens elsewhere in the plan?

The answers start telling us how that money should be handled, based on what your life needs from it.

The tool follows the job

Retirement planning can get backward pretty quickly.

The conversation starts with a product or investment. Should I own more bonds? How much cash should I keep? Do I need an annuity? Should I stay invested in stocks?

Each of those is a reasonable question. They're hard to answer well without understanding the job first, because the job changes what you're trying to accomplish with the money.

An emergency reserve

For money that could be needed tomorrow, access and stability are especially important.

The household needs to know how much is available, how quickly it can be reached, and what using it would mean for the rest of the plan. Growth is usually a secondary concern for money that needs to be accessible on short notice.

Spending over the next few years

Money designated for upcoming withdrawals has a different responsibility.

The question becomes what happens if markets decline shortly before that money is needed.

Cash, short-term high-quality bonds, or other appropriately protected resources may help address that need. Even high-quality bonds can fluctuate in value, particularly if they must be sold before maturity.

Money you won't need for fifteen or twenty years

Longer-term money may be able to carry more investment risk because there's more time before it needs to be spent.

Growth also becomes more important when inflation has years to reduce purchasing power. A diversified investment portfolio may make sense for this responsibility, depending on what the household can afford to risk and how comfortable it is staying invested through market declines.

Income that needs to last as long as you do

Social Security and any pension benefits may already cover part of this responsibility.

For the remaining need, portfolio withdrawals are one option. Purchased lifetime income through an annuity may also deserve consideration, particularly when dependable income doesn't cover essential spending.

A lifetime income contract can transfer part of the risk of living longer than expected to an insurance company, subject to the contract's terms and the insurer's claims-paying ability.

The tradeoffs can include less access to the money committed, explicit or embedded costs, inflation exposure, and different outcomes for a surviving spouse or heirs.

The amount of dependable income already available, the household's need for liquidity, and its other financial obligations all affect whether purchasing additional income makes sense.

Legacy

Money intended for children, family members, or charity raises another set of questions.

How much do you want to preserve? How important is leaving a specific amount? And how much flexibility do you want to spend those resources during your lifetime if your priorities change?

Taxes, account ownership, beneficiaries, and the resources needed for your own retirement can all affect how that part of the plan is structured.

Within the same household, different dollars can carry very different jobs, and each job values something different.

Once those jobs are clear, comparing financial tools gets easier because you know what you're asking each one to accomplish.

The tool follows the job, and the job follows what you want your life to look like.

Why this helps when markets get rough

This way of thinking becomes especially useful when markets start moving.

Imagine the market drops sharply a year or two after you retire.

If your retirement savings are one big pool in your mind, the questions can pile up quickly. Should I sell or wait? Where does next year's spending come from? Can we still take the trip we planned? What happens if another unexpected expense shows up?

Having a plan for the different jobs your money needs to perform gives you a starting point for those decisions.

You know which resources were designated for near-term spending and which investments have a longer time horizon. You also know what money is available for an emergency without creating additional pressure on your future income.

Withdrawing from investments during an early market decline can put additional pressure on retirement assets. That's part of the sequence-of-returns risk discussed in our article, Where Does Your Retirement Paycheck Actually Come From?

Money set aside for near-term spending can buy time, but it can't guarantee markets recover before that reserve runs out. A prolonged downturn may still require adjustments, and the reserve will eventually need to be replenished.

The benefit is having a reason behind how the money is organized, along with a plan for what happens when conditions change.

Comparing retirement income strategies against the job

The same thinking applies when deciding how to turn savings into retirement income.

There are several reasonable approaches.

Systematic portfolio withdrawals allow you to take income from investments while maintaining access to the remaining assets.

Some methods begin with a specified withdrawal amount, such as the familiar 4% approach. Under that approach, the initial withdrawal is generally followed by inflation adjustments to the dollar amount in later years.

Other methods use guardrails, with rules for raising or trimming spending when the withdrawal rate crosses predetermined limits.

The historical research behind the 4% rule is a useful reference, but a particular percentage doesn't establish what every household can sustainably spend.

Time segmentation, often called a bucket strategy, separates money according to when you expect to need it. The goal is to have resources designated for upcoming withdrawals while allowing other investments more time to grow.

Purchased lifetime income can provide contractual payments for some of the household's spending needs, potentially reducing how much the remaining investments must provide.

What does the strategy leave for the other jobs in the plan?

That question is more useful than simply comparing which method produces the largest payment. A larger payment may come with less access to the original capital, different survivor benefits, or fewer remaining resources for other goals.

Similar finances can lead to different retirement plans

Two households with similar finances can reasonably organize their retirement income in different ways.

One may be comfortable with market swings and want to maintain as much flexibility as possible. Another may place more value on having a larger portion of its income contractually protected.

A third may prefer money separated by time because knowing the next several years of spending are accounted for makes it easier to leave long-term investments alone.

That's why I like to keep three questions separate.

1. What level of financial uncertainty can the household actually absorb?
2. What level of uncertainty can you personally tolerate without abandoning the strategy when things get uncomfortable?
3. How do you prefer your retirement income to show up?

A strategy someone abandons during a downturn can create problems regardless of how reasonable the original investment analysis looked.

Your preferences belong in the planning process because you'll be the one living with those decisions.

What changes once each dollar has a job?

When the jobs and your preferences are clear, several retirement decisions become easier to evaluate.

You can distinguish money that's truly available from money already committed to future income. You can see which dollars have enough time to take investment risk and what happens to the rest of your plan when you make a large purchase.

You can also evaluate an investment, income strategy, or tax decision based on how it affects your broader financial picture.

You're less likely to expect one portfolio balance to deliver maximum income, maximum liquidity, maximum safety, maximum growth, and a guaranteed inheritance all at once.

Every financial tool comes with tradeoffs. Giving your money a job helps you decide which ones make sense for the life you're trying to support.

Start with one question

If you're getting close to retirement, here's a question worth asking about every meaningful pool of money you have.

What is this money for?

Then keep going. When will I need it? How accessible does it need to be? What level of risk can it reasonably carry? If I use it for something else, what happens to the rest of my plan?

Those answers provide a much better starting point for decisions about investments, retirement income, cash reserves, insurance, and taxes.

Your portfolio may have a lot of jobs. The goal is understanding which dollars are responsible for which ones and whether your resources can support everything you're asking them to do.

If you'd like help putting those pieces together for your own situation, that's the kind of retirement planning we do at One Life Advisory. You can learn more about what we do here.