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Creating a Paycheck for Retirement – A Series on Retirement Income Planning
Whatever your retirement dreams, they can still be made a reality. It just depends on how you plan and manage your resources. On any journey it helps to have an idea where you’re going, how you plan to travel and what you want to do when you get there.
If this sounds like a vacation, well, it should. Most people invest more time planning a vacation than something like retirement. And if you think of retirement as the Next Act in your life and approach it properly, you won’t be so easily bored or run out of money to continue the journey or get lost and make poor money decisions along the way.
It’s How You Manage It That Counts
How much you need really depends on the lifestyle you expect to have. And it’s not necessarily true that your expenses drop in retirement. Assuming you have an idea of what your annual expenses might be in today’s dollars, you now have a target to shoot for in your planning and investing.
Add up the income from the sources you expect in retirement. This can include Social Security benefits (the system is solvent for at least 25 years), any pensions (if you’re lucky to have such an employer-sponsored plan) and any income from jobs or that new career.
Endowment Spending: Pretend You’re Like Harvard or Yale
Consider adopting the same approach that keeps large organizations and endowments running. They plan on being around a long time so they target a spending rate that allows the organization to sustain itself.
1.Figure Out Your Gap: Take your budget, subtract the expected income sources and use the result as your target for your withdrawals. Keep this number at no more than 4%-5% of your total investment portfolio.
2.Use a Blended Approach: Each year look at increasing or decreasing your withdrawals based on 90% of the prior year rate and 10% on the investment portfolio’s performance. If it goes up, you get a raise. If investment values go down, you have to tighten your belt. This works well in times of inflation to help you maintain your lifestyle.
3. Stay Invested: You may feel tempted to bail from the stock market. But despite the roller coaster we’ve had, it is still prudent to have a portion allocated to equities. Considering that people are living longer, you may want to use this rule of thumb for your allocation to stocks: 128 minus your age. Regardless, you really should keep at least 30% of your investment portfolio (not including safety net money) in equities.
If you think that the stock market is scary because it is prone to periods of wild swings, consider the risk that inflation will have on your buying power. Bonds and CDs alone historically do not keep pace with inflation. Only investments in equities have demonstrated this capability.
But invest smart. While asset allocation makes sense, you don’t have to be wedded to “buy-and-hold” and accept being bounced around like a yo-yo. Your core allocation can be supplemented with more tactical or defensive investments. And you can change up the mix of equities to dampen the roller coaster effects. Consider including equities from large companies that pay dividends. And add asset classes that are not tied to the ups and downs of the major market indexes. These alternatives will change over time but the defensive ring around your core should be reevaluated from time to time to add things like commodities (oil, agriculture products), commodity producers (mining companies), distribution companies (pipelines), convertible bonds and managed futures.
4.Invest for Income: Don’t rely simply on bonds which have their own set of risks compared to stocks. (Think credit default risk or the impact of higher interest rates on your bond’s fixed income coupon).
Mix up your bond holdings to take advantage of the characteristics of different bond types. To protect against the negative impact of higher interest rates, consider corporate floating rate notes or a mutual fund that includes them. By adding Hi-Yield bonds to the mix you’ll also provide some protection against eventual higher interest rates. While called junk bonds for a reason, they may not really be as risky as other bonds. Add Treasury Inflation Protected Securities (TIPS) that are backed by the full faith and credit of the US government. Add in the bonds from emerging countries. While there is currency risk, many of these countries do not have the same structural deficit or economic issues that the US and developed countries have. Many learned their lessons from the debt crises of the late 1990s and did not invest in the exotic bonds created by financial engineers on Wall Street.
Include dividend-paying stocks or stock mutual funds in your mix. Large foreign firms are great sources of dividends. Unlike the US, there are more companies in Europe that tend to pay out dividends. And they pay out monthly instead of quarterly like here in the US. Balance this out with hybrid investments like convertible bonds that pay interest and offer upside appreciation.
5. Build a Safety Net: To sleep well at night use a bucket approach dipping into the investment bucket to refill the reserve that should have 2 years of expenses in near cash investments: savings, laddered CDs and fixed annuities.
Yes, I did say annuities. This safety net is supported by three legs so you’re not putting all your eggs into annuities much less all into an annuity of a certain term. For many this may be a dirty word. But the best way to sleep well at night is to know that your “must have” expenses are covered. You can get relatively low-cost fixed annuities without all the bells, whistles and complexity of other types of annuities. (While tempting, I would tend to pass on “bonus” annuities because of the long schedule of surrender charges). You can stagger their terms (1-year, 2-year, 3-year and 5-year) just like CDs. To minimize exposure to any one insurer, you should also consider spreading them around to more than one well-rated insurance carrier.
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