Investing/Planning for long-term cash flow needs

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TonyUncleJohnny
Posts: 35
Joined: Wed Jan 03, 2018 4:02 pm

Investing/Planning for long-term cash flow needs

Post by TonyUncleJohnny » Mon Apr 09, 2018 2:10 pm

My question is somewhat along the lines of retirement-income / safe-withdrawal-rate, though I am relatively young (36). I am planning some investments to fund certain expenditures over the next ~20 years.

My specific needs are as follows,
For 16 years starting the year 2021 until the year 2037, I will need a cash flow (in hand, post tax) of $70,000 for expenditure A.
For 20 years starting the year 2018 until the year 2038, I will need a cash flow (in hand, post tax) of $43,000 for expenditure B.

or we could just simplify and say I need a cash flow of $115,000 (in hand, post tax) for 20 years starting 2018 until 2038.

For tax rate assumptions - Married couple filing jointly making $300k per year. 2 kids.

If I was to start today with a lump-sum and invest "appropriately", such that the aforementioned cash flow needs are met, and I am left with $0 at the end of 20 years, how much money would I need today?

And how best would that money be invested to accomplish said goals?

While the projected spend won't have any flexibility in "down" years, a reasonable amount of volatility in the investments is fine. There are other buckets we can pull cash from in such times.

Many thanks for sharing your experience and opinions.

Tony

alex_686
Posts: 3369
Joined: Mon Feb 09, 2015 2:39 pm

Re: Investing/Planning for long-term cash flow needs

Post by alex_686 » Mon Apr 09, 2018 2:29 pm

TonyUncleJohnny wrote:
Mon Apr 09, 2018 2:10 pm
And how best would that money be invested to accomplish said goals?
2 answers. In short we are going to need more info.

The first answer is that you need to do a Net Present Value calculation, or NPV. There are many online calculators out there. You will need to do one for each cashflow. Spreadsheets can do this too, and can combine multiple cashflows into a single calculation. They will ask you for your starting amount, payments, expected return, and ending amount. You need to specify either a starting amount or a expected rate of return, which you have not. I will let you mull that over as we go on to ...

Secondly, any answer that we will give you will be vague. My first impulse was to suggest a fairly aggressive portfolio because it is madness to try to predict what the market return will be over 10 years. I can do 10 years - but everything beyond that is pure guesswork. But I was wrong.

This is partly what your market expectations are and what your risk tolerance is. People say that the longer the time horizon the more risk you can take. This is wrong. It is true for most people because they have flexibility - which is what really matters. If you are 5 years into a 20 year plan and it goes off the rails most people can compensate. Lower goals, increase savings, etc.

However as I have gotten older and wiser I know this is not true for all people. Some people lack flexibility, have very hard minimum required goals, or have low risk tolerance.

So we are going to need to know your market expectations and risk tolerance before we go further.

FYI, my guess is that a 70/30 AA will have a real return 4% +/- 3% over the next 10 years. With that you will get 38k and 20k. I am not factoring in any tax drag.

TonyUncleJohnny
Posts: 35
Joined: Wed Jan 03, 2018 4:02 pm

Re: Investing/Planning for long-term cash flow needs

Post by TonyUncleJohnny » Mon Apr 09, 2018 3:04 pm

Alex_686,

Many thanks for your thoughts.

What I'm really looking for is experience-based recommendation for a reasonable rate of return to expect and best portfolio allocation to accomplish this. I am indeed familiar with time value of money concepts and NPV, etc. methods to come up with the starting amount.

Assuming a tax rate of 25%, I would need pre-tax cash flow of $153k for $115k cash in hand.

Going with your mid-point of 4% real return, I would need starting capital of $2.1m to pull out $153k each year over 20 years. If that can be done, I think I'm very happy.

But I want to hear as many opinions and real-life experiences as possible to make sure I go into this with the right expectations and the best possible strategy.

Is 4% real a reasonable expectation for this timeline, and what is the best portfolio allocation to pull this off? Again, some volatility is okay.

You propose 70 Equity / 30 Debt. Others agree / disagree? And within the Equity and Debt buckets, would you recommend certain options over others (intermediate vs long-term bond, dividend stock funds, etc.).

Again, many many thanks for yours and everyone's opinions and experience, especially those who who have implemented this in real-life.

ExitStageLeft
Posts: 175
Joined: Sat Jan 20, 2018 4:02 pm

Re: Investing/Planning for long-term cash flow needs

Post by ExitStageLeft » Mon Apr 09, 2018 4:04 pm

If you go to immediateannuities.com you can see a 40-year-old can get a 20 year certain annuity with a payout of 6.75% per year. If it's purchased with already taxed funds then the portion that is taxable is what is paid out on top of the original purchase price. For 20 years at 6.75% that means 26% of the payout will be taxable. Based on all that, you could meet your needs with the following:

- Spend $1.83M for 20 years of guaranteed income at $122,970.
- Of that, the taxable portion will be 26% * $122,970 = $31,881
- With a 25% marginal tax rate, the taxes will be 25% * $31,881 = $7,970
- Annual payout of $122,970 less taxes of $7,970 leaves spendable amount of $115,000

If your lump sum is tax-deferred then your analysis of needing $153k pre-tax per year is correct. If it is already taxed then any other plan whereby you spend down the principal will also have a tax calculation similar to the annuity above.

If your cash flow need is pretty certain, an annuity might make sense.

alex_686
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Re: Investing/Planning for long-term cash flow needs

Post by alex_686 » Wed Apr 11, 2018 12:34 pm

Since nobody has responded I will answer.

Your questions about asset allocation and expected return are often batted around here. Check back and I am sure you can find a thread or two.

Historically the equity market has returned closer to 10% nominal and 7% real. I based the 4% real return based on a 5% real return on equities, which is based CAPE10, Secular Stagnation, and the New Normal theories which suggest lower real returns for the future. . Let us know if you want to dig into any of these. For bonds, the 10 year Treasury is yielding around 2.5% nominally. Treasury Inflation Protection Securities are yielding around .7%.

On the asset allocation side, 70/30 and 60/40 have solid theoretical and historical backing. As a suggestion you can check out some target date funds and see what their asset allocation is like.

The problem that I face in answering your question is that I want to know what these cash flows are going to be used for. What is your risk tolerance if you fail to meet these. What happens if you overshoot? What one is supposed to do is look at your portfolio as a whole - taxable, tax advantaged, human capital, Social Security, etc. and put together a plan that address all of your goals. More complex but a better answer.

We are talking about 20+ years. Tax policies will change, structural changes will happen in the stock market, etc. At this point I only feel comfortable offering very generic advice.

TonyUncleJohnny
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Joined: Wed Jan 03, 2018 4:02 pm

Re: Investing/Planning for long-term cash flow needs

Post by TonyUncleJohnny » Wed Apr 18, 2018 1:50 pm

ExitStageLeft and Alex_686,

Very helpful posts, thank you both, and my apologies for the delayed response.

The cash flows are going to be used for certain personal / family expenses that are expected to keep pace with inflation, but otherwise not change.
Risk tolerance if the money runs out is very high; there are other large reserves to fund any shortfall. Same if the goal is overshot, and a meaningful amount of money is left at the end; the opportunity cost of that money not having been invested elsewhere (90 or 100% equities for example) will not cause any heartburn either.

When you say TIPS are yielding 0.7%, is that after accounting for inflation?

Given that I expect these expenses to grow at the rate of inflation, would a simple way to plan be to multiply current annual expense by # of years and use that as the starting lump sum? As long as the portfolio keeps pace with inflation, it will meet cash flow needs.

All that said, this decision is about a year out. Hopefully I'm more educated by then and thus in a better position to make said decision.

On that note, any books you would recommend on the topic of portfolio allocation? I'll also check out the bogleheads wiki / stickies and Taylor Larimore's posts for recommendations.

dbr
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Joined: Sun Mar 04, 2007 9:50 am

Re: Investing/Planning for long-term cash flow needs

Post by dbr » Wed Apr 18, 2018 4:19 pm

In general a specific liability should be matched by a specific source of income. That means either a period certain annuity or a ladder of bonds. If you want to approach the problem by using a volatile portfolio with uncertainty as to outcome and makeup the shortfall with "other" funds then you have changed the question. If the idea is to supply the cash flow but also risk the resources for greater return, that is ok but I think that is also a different question.

But without prying too much into your affairs, it seems odd that a person would need a future cash flow from current assets rather than just buying the NPV flat out now. But that is ok if that is what it is.

TonyUncleJohnny
Posts: 35
Joined: Wed Jan 03, 2018 4:02 pm

Re: Investing/Planning for long-term cash flow needs

Post by TonyUncleJohnny » Fri Apr 20, 2018 7:51 pm

Dbr,

Yes, a period certain stream of cash / ladder of bonds is indeed what I was thinking and wanted help with the logistics of setting it up. While I would like to plan the investments such that the cash flow needs are met exactly as expenses are projected, a slight shortfall would not jeopardize things as there are other "buckets" of funds I could tap into. But you're right, it's two different questions.

Not sure I understand the part about "buying the NPV flat out now". Could you please elaborate?

To offer some color on my situation, my cash flow needs are relatively modest at the moment, but going forward they are expected to go up as detailed in my original post. Let's say I have a large "bucket" of funds right now, some of which I plan to invest for long-term wealth creation, and some to fund the aforementioned future expense stream. How best to set things up to meet the latter goal is what I'm trying to understand.


Many thanks for your thoughts.

dbr
Posts: 26635
Joined: Sun Mar 04, 2007 9:50 am

Re: Investing/Planning for long-term cash flow needs

Post by dbr » Sat Apr 21, 2018 9:20 am

TonyUncleJohnny wrote:
Fri Apr 20, 2018 7:51 pm
Dbr,

Yes, a period certain stream of cash / ladder of bonds is indeed what I was thinking and wanted help with the logistics of setting it up. While I would like to plan the investments such that the cash flow needs are met exactly as expenses are projected, a slight shortfall would not jeopardize things as there are other "buckets" of funds I could tap into. But you're right, it's two different questions.

Not sure I understand the part about "buying the NPV flat out now". Could you please elaborate?

The question is whether this originates in a need to pay back a loan or something where the better approach is to pay up front and not borrow the money. Possibly the need is easier to understand if we knew what it was.


To offer some color on my situation, my cash flow needs are relatively modest at the moment, but going forward they are expected to go up as detailed in my original post. Let's say I have a large "bucket" of funds right now, some of which I plan to invest for long-term wealth creation, and some to fund the aforementioned future expense stream. How best to set things up to meet the latter goal is what I'm trying to understand.


Many thanks for your thoughts.

TonyUncleJohnny
Posts: 35
Joined: Wed Jan 03, 2018 4:02 pm

Re: Investing/Planning for long-term cash flow needs

Post by TonyUncleJohnny » Sat Apr 21, 2018 8:47 pm

DBR,

The cashflow will not be used to pay off loans, and it's not a situation where you could just purchase the present value of the spend and be done with it.

Sent you a PM.

Thanks,
Tony

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