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Why Cash Flow Matters More Than Net Worth · Retire and Thrive

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Cash flow is a predictable income source, whereas the
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market doesn't have a consistent income generator.
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In other words, the income you generate from your portfolio can
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often be dependent on what the market value of your portfolio
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is. Nothing static.
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Things change very rapidly today relative to even five years ago.
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I think it's not only important that you review the investments
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on an annual basis, but definitely review cash flow
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annually. Welcome back to another episode
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of Retire and Thrive where I focus on helping you live that
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stage of retirement with purpose, wealth, and confidence.
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We're continuing to dive into a little bit more of the strategy
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on this Retire and Thrive podcast.
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And this is now episode 27. And I don't want to feel like a
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broken record here, but this is a heavy episode.
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So I'll try to keep it somewhat simplistic, but this episode
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I've titled Why Cash Flow Matters More than Net Worth.
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And if I haven't conveyed this enough in the previous episodes,
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we're going to kind of dive into a little bit heavier today.
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And so I think this is really kind of crucial for people that
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are retired. And so, you know, my first
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comment that I would make is that the cash flow actually pays
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the bills, the net worth doesn't.
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And so often times when we meet with people and they're about
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ready to retire, they like to focus on how much they have or
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what their net worth is. And I've got clients of mine
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that have very large net worth and they do struggle cash flow
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wise. But yet I have clients that
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don't have a large net worth and they have more income than they
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know what to do. And I won't necessarily call
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anybody out here, but I'll just give you an example.
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One of my larger clients has about a $5,000,000 net worth and
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that net worth consists of two homes, one down in Florida and
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one back here in Minnesota. It also includes about
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$2,000,000 in a portfolio. And then on top of that there's
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some other assets, non tangible assets such as cars and
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collections and so forth. And so the challenge for that
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client of mine is that they have a fairly high lifestyle.
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They focused on saving during retirement.
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Everything they've got is pre tax.
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And his four O 1K or now IRA is about 1.5 million.
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Her four O 1K is about 500,000. So again, that's a combined
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about a $2,000,000. The challenge is, is that they
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have taken Social Security. They're now in their mid 60s.
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Social Security generates about $40,000 per year.
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However, they're pulling money out of their portfolio to the
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tune of about $70,000 per year. And the challenge with the
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$70,000 per year, by the time we do the withholding, they're
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actually netting closer to $48,000 per year.
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The difference, roughly $22,000, is what we withhold for taxes.
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They happen to be residents of Minnesota, so state and federal
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is about $28,000 of withholding. And so they're generating about
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$4000 per month from the IRA account.
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And it seems like every quarter they're a little bit short.
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So the two Social securities and the net of $4000 per month isn't
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enough for them to make it. But yet when we look at the
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portfolio, they have two beautiful houses.
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They've got a nice portfolio, but with their income between
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the Social Securities and the amount we're pulling out, it
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just isn't enough. So in their particular case,
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with a $5,000,000 net worth, it's challenging for them.
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So the net worth doesn't pay their bills.
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Now on the other hand, we've got clients of ours, husband and
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wife, maybe they work for the same company.
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That same company kicked out a pension to them and they take
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Social Security. And between the two pensions
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that they're receiving and the Social Security, they have more
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income than they know what to do with.
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And in this particular case that I'm referring to, this couple is
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in their early 60s and their retirement, some is Roth, some
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is pre tax combined is about $400,000.
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And they come in every year and they say we have more income
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than we know what to do with. And periodically they'll tap
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their retirement accounts. And it may be something just
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very silly like we need $10,000 because we want to treat our
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kids to a special trip or we need $5000 at Christmas time
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because we're going to do gifts. So again, 2 completely different
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opposite net worths, but yet that's why the cash flow matters
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and net worth doesn't. The second thing as it pertains
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to cash flow that I want to touch about is cash flow is a
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predictable income source, whereas the market doesn't have
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a consistent income generator. In other words, the income you
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generate from your portfolio can often be dependent on what the
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market value of your portfolio is.
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So again, if we were to compare a portfolio of $1,000,000 401K
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and compare that to somebody generating A pension, what's my
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preference? Well, it really depends.
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Again, it depends on all the other assets that they may have.
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But if that's all they had, if they had a choice of $1,000,000
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portfolio or $65,000 a year from their pension, not always.
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Some of it's going to be dependent on risk, some of it's
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going to be dependent on how much they want to leave to their
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kids. But as a general rule, I would
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say I would prefer the $65,000 of guaranteed income from the
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pension. And again, if there's other
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circumstances, whether it's health, whether the amount would
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be left to a surviving spouse, but just all things being equal,
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I would say taking the monthly income or the annual $65,000 a
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year gives you that guaranteed predictable income versus the
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$1,000,000 portfolio. When we look back and remember
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we talked about that 4% sustainable withdrawal rate
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would generate 40,000. In other words, we would need to
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get 6 1/2 percent return on $1,000,000 portfolio to equate
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to that predictable income and not saying that we couldn't get
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6 1/2%, but it will not be a straight 6 1/2 percent.
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We may see that fluctuate. The third thing I want to talk
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about when it comes to cash flow is what I call the three bucket
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system. Now we don't necessarily follow
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the three bucket system to AT, but the system goes something
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like this and I think it has some merit to it.
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The merit is this. If I retire exactly at 60, this
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is a simplistic version and I know what my income needs are
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going to be. I could take a certain dollar
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amount and I could put it invested in some guaranteed
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accounts for the 1st 10 years of retirement.
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So from age 60 to 70, let's say that I need $2000 a month.
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So in that particular case, maybe you carve out $24,000 in
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your portfolio to put in year 1 and year 2 and year 3 all the
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way out through year 10 so that you get that $2000 per month
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guaranteed. So we've now just carved out,
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again, this is simplistic, but roughly $240,000 out of your
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portfolio for bucket number one. Bucket number 2 is I'm going to
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need that from age 70 to 80. And so I'm willing to take a
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little bit more risk, but it might be fairly conservatively
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invested. So it could be something like
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70% bonds, 30% stocks, 60% bonds, 40% stocks.
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But the whole concept is this, that that portfolio for the
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second decade of retirement isn't going to have massive
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fluctuation. It might have a little bit of
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fluctuation, but we can take on a little bit more risk.
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And then the third bucket would simply be much more aggressive
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because in theory, if I retired at 60 and the third bucket is
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money, assuming that I live to be age 80 is from age 80 to 90
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and I can handle more risk. So from age 80 to 90, it might
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be something as aggressive as 80 stock, 20 bonds or 70 stock, 30
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bonds. And the whole theory is that in
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the beginning, we want safe and secure for the 1st 10 years.
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And as you get closer and closer to that next decade, say from 60
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to 70 depending on several circumstances, if your life has
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all remained the same financially, that's great.
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If the markets are doing well, that's great.
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But if the market's done really great, we may want to accelerate
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certainly the second and third bucket and start moving some of
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that into the lower tier or the lower risk.
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But that's the three bucket system.
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We use a similar concept in terms of keeping things liquid
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for a couple of years to provide liquidity so that we're not
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selling in a down market when in fact we need the money.
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The next thing I want to talk about is cash flow creates
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emotional security and the best thing that I could example I can
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give you is often times when we run numbers for clients as they
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are approaching retirement, we've got several employers in
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town here that do offer pensions.
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So we know pensions very, very well and generally speaking,
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there's several decisions that the retiree needs to make.
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First and foremost is do I take a monthly income or do I take
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this lump sum? And again, that was kind of
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going back to predictable income versus be dependent on the
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market values or performance. So the emotional security in
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that is I can take an income or I can take it as a lump sum.
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Now, a lump sum might make you feel better because it's an
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asset and it shows up on your balance sheet and the income
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doesn't really even show up. But even on the income side,
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there's decisions to make of do I take it just on my life?
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If you're married, do you add your spouse?
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And if you add your spouse, do they get 100% of that?
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Do they get 50 percent, 25%? So there's all these choices you
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have to make. But back to the emotional
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security. If I know regardless of what's
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happening in the market, I'm going to get a paycheck for my
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pension every single pay period, that creates some emotional
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security. Kind of closely tied into that
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is I want to just explain the difference between income and
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withdrawals. Again, I'm going to tie it back
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to the pension. The income is that emotional
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security that makes me feel good because it doesn't matter what
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happens when I hear the markets down, I don't have to worry.
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But that's the emotional security, but that's income
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coming in. In other words, you don't have
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to do anything. The markets don't have to
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perform. Generally speaking, when people
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take that monthly income from their pension, or it could even
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be the Social Security, normally that just gets deposited right
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to their bank account. So a lot of people think of it
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quite honestly as this is kind of like my paycheck, this is
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what I used to receive or something similar.
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So that's where we talk about income.
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The withdrawals on the other side, completely the opposite.
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If you took a portfolio and you were doing again that 4%
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withdrawal rate, you're taking that income and it feels good.
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But if you had $1,000,000 in the market, dropped by 10% and you
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are vested in the market and you're pulling out that 4%,
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guess what? It's a little scary when your
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portfolio, say, drops to 900,000 and you're still pulling out the
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$40,000 per year. And often times it can be quite
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frankly upsetting because people are looking at that and saying,
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Oh my word, I just lost $100,000, maybe I should shut
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off this income. So that's the difference between
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withdrawal and income. And this ties into the next kind
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of comment or lesson that I wanted to touch on and that is
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building your retirement paycheck.
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Building your retirement paycheck is setting yourself up
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to replace some or all of the income that you had when you
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were getting paid. I will never forget about two
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years ago, we had a client of ours retired, very successful,
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was a corporate executive and we ran through all kinds of
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scenarios and it was all tied to cash flow and where's the
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income, you know, coming from and so forth.
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And so we showed him, here's how much you'll get in Social
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Security to work for a big corporation.
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Here's here's what your pension amount is going to be.
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We're going to assume you're going to take the monthly
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income. Here's how much additional we're
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going to pull from your portfolio.
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To give you an example, I've got a corporate executive that we've
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worked with and when we talked about the building, the
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retirement paycheck, and I'll never forget this.
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This was a couple of years ago. He and his spouse had great
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income sources. He had a very nice pension.
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She from her family owned some farmland, so they had income
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coming in from the farm. And then they both looked at
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Social Security and when we added everything up together,
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about 70% of all of their income coming from those sources
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covered their overall expenses. So in other words, we need to
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pull out 30% of their portfolio to basically for them to to live
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that lifestyle that they wanted. And so they had built that
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paycheck over the years of farm income.
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Whether you want to look at Social Security as building your
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paycheck, it's going to continue to come in month in and month
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out. And his pension, so I'll never
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forget about six months after that he, he came in and he said,
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you know, I get all of the numbers and it makes a lot of
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sense. But I'm used to like having a
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paycheck come in every single pay period.
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And now you're talking about social securities and pensions
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and the farm income. And how does that all play into
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it? So we basically went into his
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cash flow report and I said 70% of your income is covered no
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matter what. Every day you wake up or every
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month you got that paycheck coming in.
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The farming income was actually twice a year, but you have that
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income coming in and what you do with that is entirely up to you.
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And then what we're going to do is we're going to take out of
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your portfolio that additional amount that you need, that 30%
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and we'll deposit that into your bank account and you can look at
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that as your paycheck. The last thing I want to say
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about cash flow is nothing static.
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I feel like things change very rapidly today relative to even
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five years ago. And so I think it's not only
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important that you review the investments on an annual basis,
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but definitely review cash flow annually.
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When we build out retirement plans for people as they
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approach retirement or if in fact they are retired.
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One of the things we find the biggest variance on is when we
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say what is your budget? And often times one spouse would
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look to the other spouse and say what is our budget?
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Well, we've never really had a budget.
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Well, when they put together a budget, often times they're
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surprised at how much they are spending.
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Some of it may be frivolous, some of it may be on things they
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didn't necessarily anticipate. But I think it's critical that
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once you're retired that you adjust your spending or at least
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have a hard look at it at least annually.
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We have clients of ours that have been with us for 10 years
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and they're still getting the same dollar amount.
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And I'll say to them, so are things a little bit tight?
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And they're like, well, they are kind of tight.
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How did you know? And I said, well, there's this
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thing called inflation. You should be adjusting.
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And they're like, yeah, but we're getting by.
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And I always say, is that what you want to do is to get by?
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So I encourage you once you're retired to adjust or at least
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look at your income sources on an annual basis and adjust means
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let's at least look at the budget.
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You know, my very first lesson in the book retire and Thrive is
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enjoying the fruits of your labor.
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So in retirement, this is not the stage to be frugal and not
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do the things that you want to do, but it is the stage for you
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to take a hard look at where you are spending your money and if
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necessary, adjust it on an annual basis.
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Thank you for joining this episode.
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I hope this episode on cash flow was meaningful for you.
17:19
And again, if you'd like to subscribe and get this into your
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inbox on a weekly basis, just click on the subscribe button
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below. And until next week, this is Dan
17:28
Langworthy with the Retire and Thrive podcast.
17:32
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