068 – The Best Way to Invest for Retirement Income

How will you get income once you are in retirement?  Do you have a plan?  Tune in and find out the best way to accomplish the goal.  Special thanks to Sergey Sanco for his article related to this episode. When it comes to tapping savings in retirement, many retirees fall into what I call the Income Investing Trap. They tilt their portfolios almost exclusively toward “income” investments—dividend stocks, high-yield bonds, annuities, etc.—figuring this is the best way to assure a safe supply of spending cash throughout retirement. Big mistake. Not only can that approach can leave you with a lopsided portfolio—which is never a good idea—but many investments pitched to retirees as secure sources of income may not be as rock-solid as they seem. For example, investors who bought high-yield and emerging market bond funds in search of higher payouts suffered losses of 3% to 4% between mid-November and mid-December, as falling oil prices and currency jitters disrupted bond markets. A more effective strategy: Invest your nest egg in a broad range of assets that can provide not just current income but capital growth as well. That way, you can then get the retirement spending money you need not just from interest and dividend payments but by periodically selling shares from your stock, bond and mutual fund holdings. You can adopt this more effective, and more balanced, strategy for producing sustainable retirement income by taking these three steps: 1. Start with a reasonable mix of stocks and bonds. Of course, what’s reasonable for many retirees—say, 50% stocks-50% bonds—may be too aggressive or overly conservative for others. So the key is to arrive at a blend of assets that can deliver returns high enough to provide adequate income without subjecting you to losses so large that you’ll spend down your nest egg too quickly. You can get a sense of what mix of stocks and bonds you’ll be comfortable with by filling out the risk tolerance questionnaire in RDR’s Retirement Toolbox. I recommend that you repeat this exercise every couple of years throughout retirement, as many people become less tolerant of risk as they age. 2. Diversify your stock and bond holdings broadly. Many retirees instinctively home in on stocks that pay above-average dividends and bonds that feature outsize yields. The problem with that approach for bonds is that stretching for yield leaves you in lower-quality issues that get hit hardest at the first sign of economic weakness. Focus too heavily on dividend stocks, on the other hand, and you may end up with shares of companies concentrated in just a few industries,  leaving you vulnerable if those sectors falter. During the financial crisis, for example, the iShares Select Dividend ETF lost roughly 60% of its value, in part due to its heavy weighting of financial stocks. You’re better off creating a portfolio that mirrors the broad stock and bond markets. The easiest way to do that to invest in a total stock market and a total bond market index fund. That will give you a piece of virtually all publicly traded U.S. stocks and bonds. If you feel you want to tilt your mix a bit toward dividend shares, fine. But don’t let the make-up of your portfolio stray too far from that of the market overall. You can see how your portfolio compares to the overall stock and bond markets by plugging your holdings into Morningstar’s Portfolio Manager tool. 3. Set a sustainable withdrawal rate. The idea here is to set a withdrawal rate that’s high enough to provide an acceptable level of income, but not so high that you’ll burn through your assets early in retirement. There’s lots of debate about what that rate should be. But if you want your money to last 30 or more years, you should probably limit yourself to an initial withdrawal of 3% to 4%, and then adjust that draw annually for inflation. So, for example,