Preparing For Retirement
Think total return, not just yield
People work and save their entire lives in order to have the ability to comfortably retire at some point. Many have benefited from higher returning assets, such as stocks, to assist them in preparing for retirement. But many retirees feel that once they switch to the retirement mode, they should shift assets out of the more aggressive portfolio of stocks into a more conservative portfolio of fixed securities, usually consisting of government bonds and CDs. As they need more income, they instinctively look for investments that pay large yields. The problem is, if you invest only for yield, you will leave yourself vulnerable to inflation and perhaps credit risk as well.
For example, suppose you buy a bond and use the interest payments for monthly living expenses. As inflation takes its toll, the real value of both the interest payments and the bonds principal value will gradually shrivel. Even at a modest 2% inflation rate, the amount of necessities you can afford will be down 18% after 10 years, and 33% over 20 years. Thus, over a long period of time, inflation will eat into your standard of living during retirement.
What is the answer? To fight inflation, retirees need to keep at least a portion of their portfolio in stocks so that they earn some capital gains. This will allow you to outpace inflation over the long term. As an alternative, consider putting half of your money in high-quality, large company stocks and half in bonds with short to intermediate term maturities. With this mix, you should be able to withdraw an amount equal to 6% of your portfolio's value the first year of retirement. Thereafter, even if you increase your annual withdrawals along with inflation, historical returns suggest that your money should last long enough to see you through a 25 to 30 year retirement.
While a 6% withdrawal rate might be reasonable for this investment mix, this portfolio will not yield 6%. It will more likely be in the 3-4% range, however, you should ignore this yield and instead focus on total return. By concentrating on decent overall portfolio performance and using a mix of income and capital gains, you can sell investments periodically to supplement your dividend and interest income and meet your retirement income needs. This total return approach may also result in income tax savings since long-term capital gain income is taxed more favorably than ordinary income.
The articles and opinions
in this publication are for general information
only and are not intended to provide specific
advice or recommendations for any individual.
