There are many stellar ideas that can fail through lack of precise execution. Investing is one of those enterprises that benefits from a method that has very specific rules and parameters. Freedom itself can be built into those parameters, but systems really do help us refrain from unintentional stupidity. Drawing income from investments makes that framework even more important. Selling investments on a regular basis means there are many possible mistakes to be made, so using a system can make a significant long-term difference.
One concept talked about in the retirement community is the bucket approach for retirement income. In the bucket approach, you maintain three types of investments: short-term, medium-term, and long-term. The short-term bucket contains highly stable money, such as CD’s, money market funds, and short-term, high-quality bonds. The medium-term bucket contains bonds that have a longer duration, preferably 7-10 years. The long-term bucket holds stocks as well as any other investments that have the volatility of stocks.
How would you construct a defined process for drawing income from such a portfolio? First, you must define which bucket will provide your income each month. For example, you would probably draw from your short-term bucket every month. The easiest way to do this is to set up an automatic monthly sell order if you are holding mutual funds. If you are using an ETF for your short-term money, then you want to be sure you are not paying too much in commissions for this monthly trade.
Second, you need to decide on a rebalancing rule. For example, you could rebalance every quarter so that your short-term bucket gets replenished. You could also set parameters that initiate rebalancing when the percentages in each bucket reach certain triggers. If your original allocation was 8/32/60 (8% short-term, 32% medium-term, 60% long-term), you could require a rebalance when there is a 5% divergence. For example, after a year of drawing 5% from the portfolio, the short-term bucket would be down to 3%, requiring a rebalance. An upsurge in the market of 10% would cause your equity percentage deviate by more than 5%. A sell-off in stocks would trigger a rebalance that would cause some of your medium-term bucket to go to the long-term category.
Having a consistent process helps you get the most from your investments and enables you to have peace of mind. You worked hard to build an investment portfolio, now you should make your money work hard for you!