Time segmentation is a strategy you can use for retirement investing. It involves matching your investments with the time frame in which you will need to withdraw them to meet your retirement income needs. Since each asset you invest in will mature at its own rate, you can coordinate maturity dates to align with the schedule you are creating.
How does time segmentation work?
To better explain how time segmentation works, let’s look at an example of this method in action.
Let’s assume that Harold and Sally are both 60 years old. They plan to retire when they are 65. They want to ensure that their first ten years of retirement income are secure. If they use a time segmentation approach, they might purchase certificates of deposit, bonds, fixed annuities, or a combination of these, with amounts designed to mature and be available in the year they need them.
Let’s assume that Harold and Sally know they will need to withdraw $50,000 annually to cover living expenses from age 65 to 70. They find a series of certificates of deposit and bonds that earn rates of 2% to 4% maturing in the years when they need the money. This is referred to as a staggered bond strategy. It would work as follows:
Certificate of Deposit 1 pays 2% – matures when Harold is 65
Certificate of Deposit 2 pays 2.5% – matures when Harold is 66
Bond 1 pays 3% – matures when Harold is 67
Bond 2 pays 3.5% – matures when Harold is 68
Bond 3 pays 3.75% – matures when Harold is 69
10-year fixed bond pays 4% – matures when Harold is 70
Bond 4 pays 4% – matures when Harold is 71
Bond 5 pays 4.1% – matures when Harold is 72
Bond 6 pays 4.15% – matures when Harold is 73
Bond 7 pays 4.2% – matures when Harold is 74
Using the table above, the couple would need to invest specific amounts of money in each asset to produce the full amount needed for $50,000 (considering interest). Currently, when they are 60, it looks like this:
Certificate of Deposit 1 pays 2% – $45,286
Certificate of Deposit 2 pays 2.5% – $43,114
Bond 1 pays 3% – $40,654
Bond 2 pays 3.5% – $37,970
Bond 3 pays 3.75% – $35,898
10-year fixed bond pays 4% – $34,601
Bond 4 pays 4% – $32,479
Bond 5 pays 4.1% – $30,871
Bond 6 pays 4.15% – $29,471
Bond 7 pays 4.2% – $28,107
Total amount required: $358,451
Let’s assume that Harry and Sally have an IRA and 401(k) and other savings and investment accounts worth $600,000. After using some of their savings to cover the above time periods (which correspond to the first ten years of their retirement), they have $241,549 left. This part of their savings and investments will not be needed for 15 years. If they invest everything in stocks (preferably in the form of stock index funds), and assuming an 8% rate of return, it will grow to $766,234.
Note: Index funds, like the S&P 500, have historically produced returns ranging from 8% to 12%, although this can be higher or lower in any given year.
I refer to this part of their portfolio as the growth segment. In the years when the growth segment performs well, they will sell some stock and extend the time segment. By doing this repeatedly, they can always look ahead seven to ten years knowing that they have safe investments that will mature to meet their future expenses. They have the flexibility to sell the growth in good years and give it time to recover when it has a bad year.
Notes
About these calculations
In these calculations, I assume that all interest can be reinvested at the mentioned rate, which in reality is often not possible.
Also, I do not take inflation into account. In the real world, Harry and Sally will need more than $50,000 in five years to buy the same amount of goods and services that $50,000 will buy today. I can increase the required amount of $50,000 annually by 3% for the number of years until it is needed, and then discount it by the return on the relevant investment for use. You will need to do the math based on your personal needs and assumptions about inflation.
If Harry and Sally decide to defer their Social Security benefits until age 70, their income needs from their investments may not be exactly $50,000 per year. They may need more early on, and then less once Social Security reaches its maximum. They can use a timeline for a retirement income plan to map this out and synchronize their investments with their needs.
Benefits of Time Segmentation
When using a time segmentation approach, there is no need to worry about what the stock market did today, or even what it did this year. There will be no need for the growth portion of your investment portfolio for 15 years.
Time segmentation is completely different from the standard asset allocation approach, where money is withdrawn in a systematic manner. The approach defines cash, bonds, and stocks at a specific percentage based on how much volatility you want to handle annually. You then set up what is referred to as a regular withdrawal plan to sell a certain portion of each asset class every year (or every month) to meet your retirement income needs.
Note: With the time segmentation approach, annual market fluctuations do not matter for your retirement income goals.
Learn more about Time Segmentation
In my article “Is Reliable Retirement Income Worth 10 Minutes of Your Time,” I provide another example of time segmentation and a link to a short video that beautifully explains this concept.
A similar concept to time segmentation is the use of different financial pockets. I cover this method in the book “Pockets of Money.” As a concept, I agree with the ideas presented in the book, but I do not necessarily agree with the investments they suggest using to fill each pocket.
Source: https://www.thebalancemoney.com/time-segmentation-a-smart-way-to-invest-retirement-money-2388271
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