Real Life Resources

Think of Your Total Return When Planning for Retirement

Interest rates may remain low for the next couple of years. But that’s no reason to play fast and loose with your portfolio to generate more yield.

Going Beyond 4%

A time-honored strategy of pulling out 4% a year from a retirement portfolio to meet living expenses may not be the answer in the current low interest-rate environment. Here’s what can happen:

  1. With interest rates on high-quality bonds at low levels, many investors attempt to pump up income with high-yield bonds and stocks, REITs, preferred stocks and convertible bonds. This strategy has its risks.
    1. You may be putting your principal at risk.
    2. Let’s say a company decides to give its rich dividend the ax:  investors may then flee the stock, which may plunge.
    3. In the market downturn of 2007-2009, preferred stocks and REITs collapsed along with the rest of the stock market.
    4. A portfolio stuffed with higher-yielding, long-maturity fixed income securities would be squeezed during a long upward march in interest rates.
    5. Don’t forget inflation, which eats away at a portfolio too tilted towards income and without enough appreciation in value. With a 3.9% inflation rate, a lifestyle that takes $100K to maintain would jump to a cost of $146.6K in 10 years.

A Plan for the 21st Century

Looking at the need for cash instead of income is the key to creating an investment program that pays off long-term. Some background information:

  1. Traditionally investors have taken a bifurcated approach: using dividends and income for monthly spending needs, while holding stocks for growth.
  2. Since the 1970s, institutions, foundations and the like have taken a different road: a total return approach that combines income and capital appreciation.
    1. It’s a way to cope with unexpected inflation while preserving long-term purchasing power.

One Possible Scenario

A couple in their mid-60s with $2 million socked away and a combined income of $48K needs $120K a year to live.  Here’s how they do it:

  1. Jack and Jill need to withdraw $72K a year from their accounts, a 3.6% withdrawal rate.
  2. They invest their assets in a globally diversified 50/50 mix of stocks (and other risky assets such as commodities) and bonds. The portfolio yields about 2%. They reinvest all dividends and interest coupons.
  3. Even if the market crashed and burned, they could survive for 14 years without dipping into their stock portfolio.
  4. In normal times, Jack and Jill happily navigate the hills and dales of market volatility by generating cash from the sale of securities — while rebalancing their portfolio — rather than by depending merely on dividends and interest.

In changing times, it’s important to have a flexible approach. Talk to your advisor and determine if your retirement portfolio could use an update.

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Gerstein Fisher
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