The biggest financial change you'll face when you retire is the fact that your paycheck stops. Unfortunately, your expenses -- other than those associated with working -- don't go away just because you retire, and you'll likely face higher healthcare costs as well. Dealing with that reality requires you to take a completely different mindset with your money as you transition into retirement.

As a retiree, you'll be depending on some combination of Social Security, any pension you might receive, and your investments to cover your costs of living. To make sure your money is really there to cover your costs when you need it, you need to balance your needs for cash today with your long-term needs for inflation-adjusted cash in the future.

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How to find the balance

To be successful, you'll first need to understand how much of your costs you need your portfolio to cover once you retire. The more your costs can be covered by other sources like Social Security and a pension, the more aggressive you can afford to be with your investing even as a retiree. The more of those costs you need your portfolio to cover, the more you need to rely on bonds and cash for the higher near-term certainty they provide than stocks.

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As a general rule, any money you expect to spend in the next five years does not belong in stocks, but money you don't expect to spend for longer than that is a candidate for stock market investing. Say you expect to spend $40,000 a year in retirement and expect to get around $16,000 a year from Social Security. Social Security payments are inflation adjusted, so you'd need your portfolio to cover $24,000 per year in inflation-adjusted costs.

Based on a retirement planning rule of thumb known as the 4% rule, you'd need around $600,000 in your account to cover 30-years of inflation-adjusted costs that start at $24,000. If you assume 3% inflation -- a little higher than recent levels, but largely in line with longer-term trends, you'll need $127,419 over your first five years of your retirement. The table below shows why:















Chart by the Author. Assumes 3% inflation starting with $24,000 in first year costs.


With those five years of expenses in cash and an investment-grade bond ladder, you can consider keeping the rest of your investments in stocks. Every year as your bonds mature and you spend down your cash, you can then 'top off' the bond ladder by using stock dividends, interest from your bonds, and if the market cooperates, selling some stock. If the market doesn't cooperate, you can let your bond ladder shrink a bit in the short term, but you'll want to build it back up as the market recovers.

Turn these numbers into your end-to-end plan

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Ideally, you'll start to shift your finances into retiree-readiness around five years before you pull the trigger. If you start by buying five-year bonds and each year after that, buy another set of five-year bonds, by the time you retire, you'll have a bond ladder set up that covers your near term spending needs.

Following this plan exactly, at retirement, you'll have $127,419 in cash and bonds, and the rest of your portfolio would need to be at least $472,581 to reach that $600,000 target. That's a bit above 78% available for stock investing, which would give your portfolio an excellent chance to continue to grow as you attempt to fight off inflation over the course of your retirement.

If you're concerned that 78% in stocks is too aggressive for a retiree, you can always dial back your stock allocation in order to add another year or two's worth of longer-term bonds to your ladder. Just be aware of the trade-off you'd be making. By shrinking the stock portion of your portfolio, you're trading off part of its long-run inflation-fighting potential in exchange for stronger near- and mid-term certainty.

Cover your costs without a paycheck

Ultimately, what this plan gives you is a way to balance your need for short-term cash flow from your investments and your need for long-term inflation coverage. That allows you to comfortably address the loss of your paycheck, arguably the biggest financial change you'll face once you retire.

Chuck Saletta has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.