When planning retirement investments, there are three approaches used to generate income for retirement:
Using this approach, investors focus only on investments that generate income. The growth of capital is largely ignored or not considered when making the investment. Those who focus on income will look at bonds, dividend-paying stocks, real-estate investment trusts (REITs), and Master Limited partnerships (MLPs). The interest payments or dividends will be paid into the retiree’s bank account.
There are several risks with this approach. It may be difficult to get the income you want. Bonds have been paying very low interest rates for over a decade. People who bought bonds years ago are finding that, as their bonds mature, current interest rates are much lower. This reduces their retirement income just when they need it most.
To get more income some retirees to put their money in riskier investments. These riskier investments have been known to reduce their dividends, decline in value, or even default during the next recession.
This is a hybrid approach that uses capital gains to supplement interest and dividends. In this case, income from dividends and interests can be accumulated and held in cash until it’s paid out.
But on a quarterly or annual basis, some investment can be sold to generate additional cash for living expenses. Like many compromises, this approach suffers from the fact that it incorporates the negative aspects of the income-focused approach while reducing the opportunity for growth of principal.
This approach seeks to generate growth of principal from which an annual income can be harvested. The return comes from growth in the value of the portfolio without reference to dividends or interest payments. This approach lends itself particularly well to mutual fund portfolios designed to reduce risk. It is designed to generate an acceptable level of income and meet the risk tolerance of the retiree in mind. It avoids the temptation to reach for high-yield securities that often expose the retiree to risks that he or she may not be aware of.
Money can be set aside in a cash account that the retiree uses for monthly expenses. When the cash account reaches a certain level, it is replenished by harvesting some of the gain from the investment portfolio.
Contact an RIA (Registered Investment Advisor) to create a portfolio designed to pay you a regular paycheck during retirement.
Arie J. Korving, a CERTIFIED FINANCIAL PLANNER™ professional, has been delivering customized wealth management solutions to his clients for more than three decades. Prior to co-founding Korving & Company, he was First Vice President with UBS Wealth Management and held management positions with General Electric.