Sunday, 3 May 2015

The Great Retirement Challenge

Congratulations! You have finally accumulated $1 million in assets after working, saving and investing diligently for 20 to 30 years. The next question is, how do you convert $1 million in assets into $1 million in income streams to support your retirement? This is the question that I encountered as I thought deeper about Retiring at 40.

Many people hope that they do not need to draw down on their accumulated assets as they enter into retirement. This is a very important psychological consideration, because, if you need to draw down on your assets, how do you ensure that they will not be completely depleted before you leave this world? You would be living in constant worry, unless you have additional income streams from children and/or annuities that could last you forever.

There is another equally important reason why you should avoid drawing down on your assets. When you have to draw down on your assets to support your spending, it means that you have no choice but to sell regardless of what the market conditions are. When you have to sell in a bear market, your assets will actually deplete faster. For example, assuming that you need to spend $40,000 every year, but the market has declined by 50%  (i.e. your assets are now worth only $500,000), you would need to sell 8% of your reduced assets to achieve the same dollar amount of spending. This is actually the reversal of the Dollar Cost Averaging (DCA) methodology. All the benefits of DCA and all the discussion about Volatility is Your Friend are now reversed. To put it in another way, DCA which is your greatest friend in helping you to accumulate that $1 million in assets has become your greatest enemy when you try to cash out the assets. 

Based on the above considerations, all your spending needs must be met by dividends (and capital gains if available). On up of that, there is inflation to be protected against, to ensure that your spending power is not eroded over time. The average inflation rate is around 2% to 3% in the last 15 years. Based on 4% spending rate and 3% inflation, you will need to grow your assets by 7% each year during your retirement period. This is actually not a low figure. 

Let's assume further than stocks can generate 3% in dividends and 7% in capital gains each year on average, making a total of 10% gain. Bonds, on the other hand, can generate 4% in dividends but no capital gains. To achieve the 7% target growth rate, you would need to allocate 50% in stocks and 50% in bonds. The allocation to stocks is actually higher (i.e. more aggressive) than the common rule of thumb that says the allocation to bonds should be your age in percentage. 

Based on the above 50-50 allocation, the annual dividends generated is only 3.5% (1.5% from stock dividends and 2% from bond coupons), which is actually lower than the 4% spending rate. Thus, if you stick to the target spending rate, you will actually need to draw down on your assets. What are the options available?

Reduce Spending Rate

The safest way is to reduce your spending rate as a percentage of your assets. This means either reducing the spending amount per year to $35,000 or less, or increasing your assets to $1.15 million.

Increase Dividend Yield

The most obvious, but potentially dangerous, way is to increase your dividend yield by buying higher-yielding assets. This usually leads to some other bigger risks. For example, junk bonds have higher yields, but they also have higher default rates. It is not worth risking your assets for 2-3% higher yields, especially when you have retired and cannot make up for the loss through working.

Hold Yield-Generating Depreciating Assets

There are some investment assets that produce regular income for a period of time but the value declines over time. Examples would be leasehold properties and Real Estate Investment Trusts (REITs) that hold them. Before the lease expires, the property will generate fairly high rental income, especially if debt is used to buy the property, but the property will decline in value as it approaches lease expiry. Such depreciating assets can generate higher yields that stocks, because they do not need to deduct depreciation charges from earnings before distributing the income. 

The higher yields from depreciating assets can help you in avoiding having to sell the assets regardless of market conditions, but you must be prepared for a gradual decline in price as the properties approach lease expiry. In other words, you cannot expect to buy a REIT at $1, collect 6% yield for 20 years, and still sell it at $1 or more. You may wish to refer to REITs Are Not Forever Attractive for more details.

Sell Assets

As a last resort, you will need to sell and draw down on your assets. The key risk factors mentioned in paragraph 3 above are (1) the need to sell regardless of market conditions and (2) unpredictable volatility in the market. If you can tackle either or both of the risk factors, the consequences of drawing down on your assets are much more manageable. For example, if you have the choice not to sell in a bear market, it will protect your assets to a large extent. Alternatively, if the market can be predicted accurately to fall by a fixed percentage each year, you could calculate with much better precision when your assets will run out if you have to draw down on your assets.

This will be the subject of much thought in future.


It took me 29 years (and still counting) to learn how to invest. It will probably take me an equally long period of time to learn how to divest. When I set up this blog, the title of my first blog post was The Beginning of the End, which was a reference to "The Matrix" movie, as I believe that the stock market is a Matrix which clouds people's thinking and makes people behave differently from the real world. It is ironic that the start of retirement is not the end of the financial journey, but only the beginning of the end.

See related blog posts:


  1. Another clear and well written article Chin Wai.
    I agree it's challenging to get to the target savings and
    Equally challenging to avoid depletion.
    Givens today's high cost of living, a million may be not enough
    To live a spend as you like lifestyle.

    1. Yes, we just have to spend cautiously, on things that really matter to us.

  2. Wealth = Asset Value + Cash flow (sustainable over our lifetime)

    Asset Value of $1m alone cannot make us wealthy over our lifetime.

    We should look at both asset value and cash flow at the same time.

    1. I guess that's why people who are asset-rich but cash-poor have problems meeting their retirement needs. We need to have a balance of both to meet those needs.

  3. hi Chin Wai, another good article on the are probably the only one in this space talking about this important issue because most are in the phase of accumulation and didn't prioritize about spending down.

    some recent research seem to indicate whether its affluent or not affluent spending tends to go down. thus the consistent inflation might not be a super big (but still a consideration) factor at all

    1. Thanks. I happen to just ponder about the issue as I reached the middle point of my life.

  4. Chin Wai,

    "You have finally accumulated $1 million in assets after working, saving and investing diligently for 20 to 30 years."

    Know what happens next? 2 possibilities:

    1) Beginning of the end - we start on another journey of discovery as you have described. We do what we say.

    2) Moving the goal posts - we tell ourselves that $1 million is not the same after 20-30 years of inflation. So we drag our reluctant bodies back onto the familiar treadmill and start running all over again... We say say only.

    1. 7 early. 8 early. Pour cold water. :-(

    2. Ya lor!

      Don't know who so lude to say $1 million alone cannot make us wealthy over our lifetime?

      Right after someone has spent 20-30 years getting that $1 million :(

      So here I come with my ironic poke :)

    3. Nay, I don't plan to retire any time soon. But the thought has been planted ;)

      Correct me if I'm wrong, perhaps someone here has shown us that you don't actually need $1 million to retire leisurely ;)

  5. Don't need $1M to retire.

    25 years ago, bought 5 rooms flat and now fully paid.

    20 years ago, bought $400K condo and now fully paid. Current market value $850K and net rental income of $3.5K. Balance 70 year lease.

    Dividend income from equity $2.1K ($500K @5% yield)

    CPFlife $1.2K

    Passive income : $5.6K; ($6.8K with CPFLife 8 year later)

    Expense : $4.5K

    Surplus : $1.1K (to be reinvest into equity to build asset)

    both properties will be legacy.

    1. Thanks for sharing. It is very useful to know how people fund their retirement.