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My question is, what strategy should I use to sell the stock mutual funds to replenish the fixed-income investments as they are used up? One option is to sell equities each year to replenish the $100,000 of fixed-income funds, in which case I'll be selling in both up and down markets? Or should I use some criteria that would result in selling equities in "good" times, when the market is up? How can I know when the "up" times are?

First of all, congratulations on saving a substantial nest egg, $2.5 million is a real acheivement.

I would use your annual withdrawals to keep your asset allocation in balance. Simply withdraw enough from both equities and fixed income to maintain the allocation you want (65%/35% seems reasonable). This way you have a mechanical way of taking more from stocks when they do well and less when they don't.

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