Retirement is another planet when you examine tons of textbooks. I would not even say that because it is obvious. Nevertheless, I am aware that you might think that it is a bit premature for you. Well, after all, it seems like you should be worried more about your grades. Still, learning about finance is the best choice you could ever make. Imagine yourself as a business you started today. You are the CEO of You Inc.
Firstly, you need to learn about a concept of a cash flow. There is no chance of a business survival without it. Same as there is no way you could survive in the retirement period. Once you retire, you stop receiving salary. Therefore, you need to have a source that will replace your salary – your reservoir of savings. It is an investment portfolio.
Building a withdrawal strategy is similar to a reverse engineering of your savings strategy. In most cases, people talk about the Four Percent Rule. According to it, you could withdraw four percent of your portfolio in the first year. Afterwards, you just adjust your numbers according to inflation rates. As you see, it is not so hard.
The point is that the market is indifferent to your calculations. It behaves erratically. Sometimes the stock market plummets precisely when you need money. When you are forced to sell your stocks in such situation, you suffer permanent losses. It is what is called sequence of returns risk – stealthy murder of your dreams.
As though you run out of your inventory because of the supply chain problem. That is what happens when you are forced to sell your assets too quickly. You might run out of money before you run out of time. That is quite terrifying. Hence, it is essential to protect yourself from such situation entirely.
However, how could you do it? You need to build a bucket strategy. This method allows you to organize your money according to their function. It sounds too corporate. However, it is quite sensible.
Bucket One is your cash stash. It covers the next two years of your expenses. It is kept in a plain old high-yield savings account. It does not increase significantly. Moreover, it is protected from market storms. It is great to sleep knowing that you will be able to cover your rent.
Bucket Two is your bond tent. It is a place where you store your money for years three through ten. Compared to stocks, bonds are less volatile assets. They protect you from stock market crashes. If the stock market plummets, you spend your money from this bucket. You give yourself some time to recover.
Bucket Three is your growth engine. It is a place of your stocks. These funds are used after ten years. You never use the funds from this bucket when the market is down. Instead, you give it some time.
Rebalancing is what connects everything together. When stocks rise, you move them to your cash or bonds. And when they fall, you buy more stocks. It sounds counterintuitive. However, it works. You simply buy low and sell high automatically.
There is one more thing you need to take into consideration. Not all money is equal. There is such a thing as Roth IRA. It grows tax-free. However, a 401k is a tax-deferred account. Hence, you have to pay taxes once you withdraw your money. Choosing the correct account is vital. It could help you to save lots of money.
This is why the business metaphor is perfect in this case. You manage your personal economy. You have your assets and liabilities. Moreover, you have your revenues. Your withdrawal rate is your operating budget. Just remember not to spend more than you earn. Quite simple, isn’t it?
Hence, start small today. If you have any earnings, open a Roth IRA. Buy yourself a low-cost index fund (such as VOO or VTI). Do not care about the noise. Look at the long-term trend. A boring path is usually the most profitable.
It may seem weird that you think about it now. After all, you are still young. Your joints do not hurt yet. But starting early gives you a massive advantage. You have something invaluable – time. And it cannot be bought back.
Do not let the complexity of the process intimidate you. This strategy will change with time as you become older. You will change buckets and percentages. The idea is flexibility. There are curveballs in life. You need to catch them with your strategy.
Imagine yourself sitting on the beach in retirement. You calmly sip on your cocktail. You will be this person if you start planning now. You are building your freedom. And it is a legacy worth building.