• Pat Schultz

Are investing for accumulation and investing for distribution really that different?

What would you think if you turned on ESPN to some breaking news. In last night’s football game the New England Patriots beat Manchester United, 42-3.

The commentator says “Heads will roll in Manchester tomorrow as they face the largest defeat recorded in football history.”

Wait a second.

If you know anything about sports you know those two teams not only don’t play each other, they play completely different sports. They may both be called football in their respective countries, but they’re two different games with completely different scoring systems.

A score of 3 in American football would be unheard of, but for soccer that can easily be a match winning score. And of course Manchester United would suffer a historic defeat if their opponent scored 42 considering the highest score ever recorded in soccer is 31 points.

Just like American football and what most of the world calls football are two different sports, investing during your working years and investing during retirement are two completely different endeavors.

During your working years you’re in the accumulation phase of life. You’re working and drawing a paycheck, and those investments aren’t required to produce any income. They’re allowed to grow for future use.

On the other hand, during your retirement years you’ve entered the distribution phase. Now those investments need to produce income in the form of dividends. Those dividends will supplement your day-to-day expenses. You’re playing a completely different game.

The Accumulation Phase

While you’re working you don’t need any income from your TSP. The only thing you really need to consider is your risk appetite when it comes to your investments. Or, as we sometimes describe it, understanding how much volatility you can handle before you start waking up in a cold sweat in the middle of the night.

Your accumulation phase also has a longer time horizon. Unless you’re getting very close to retirement you can handle short term bumps in favor of long term growth. As you get closer to retirement it’s wise to start considering how to allocate your TSP to minimize those short term bumps.

I normally recommend revisiting your allocations within 5 years of retirement to help minimize any temporary downturns in those last years leading up to retirement. More on that later when we get to the distribution phase.

The other hallmark of the accumulation phase is that you’re constantly adding to your investments. Through dollar cost averaging you add a consistent dollar amount to your investments each month. This helps smooth the effect of market swings over time.

The Distribution Phase

During the distribution phase most people need their investments to produce at least some income to supplement their cost of living.

Investments that generate income, whether through dividends or interest, are different from investments that are intended for accumulation. Not only are the investments themselves different, but in the distribution phase you also need to consider how to move money into your checking account for day-to-day purchase, and whether there’s seasonality to when you need to move money from your investments into other accounts.

Investments are also more vulnerable to market fluctuations during the distribution phase. Imagine if you retired in 2008 and your TSP was all in growth investments. In the first six months of retirement your newly funded IRA could have been cut in half, plus you’d be taking distributions from it without adding money back into it. It’s not hard to envision a circumstance where you’d run out of money part way through retirement.

Another thing that needs to be considered as you plan for the distribution phase is what your cost of living will be in 10-20 years. Not only your lifestyle, but inflation also needs to be taken into account.

The most complex part of the distribution phase is having the proper mix of investments. Part of your investments need to provide income, and part needs to fight inflation to ensure you have enough to cover cost of living increases. You’ll also be required to start taking money out of your IRA once you reach 72, regardless of whether or not you need the money to cover your expenses.

Does this all seem like a lot to consider? I’ll be honest, it is.

That’s why at IFR and DWMS we’ve developed an in depth process to help federal employees transition from the accumulation phase to the distribution phase. Here’s a quick look at the various aspects we take into consideration:

  • Cash flow - to put it simply, once you retire how much will be coming in and how much will be going out? This gives us a pretty good idea of how much money you’ll need to generate from your investments in the distribution phase.

  • Risk tolerance - No one wants to wake up in the middle of the night worried that they’re going to run out of money. On the other hand, we also don’t want you to wake up wondering if you’re missing out on a bull market where you could increase the amount of money available to you. That’s why we quantify your risk tolerance and work to prevent either of those extremes.

  • Bucket allocation - The last piece of the puzzle is to ensure you have the right amount set aside for three key things:

  • A cushion for emergencies

  • Income to support the lifestyle you desire during retirement

  • Investments to fight inflation so you know you’re covered for the next 20-30 years.

As you can see, the accumulation and distribution phases really are two completely different sports. Both are equally important, but you can’t apply the same rules and scoring systems to both.