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 and annuities.
A more effective strategy: Invest your nest egg in abroad
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 also by
periodically selling shares from your investment 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 and 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
2. Diversify your
stock and bond holdings broadly.
Many retirees instinctively choose 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 investments that get hit hardest at the first sign of economic
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. You're better off creating a
portfolio that mirrors the broad stock and bond markets. The easiest way
to do that is to invest in total stock and bond market index funds. These 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
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.
Depending on how your investments perform, you may need to
lower or raise that withdrawal rate later on. Plugging your investment and
spending information into a good retirement income calculator every
couple of years can help you decide whether you need to make an adjustment.
So don't fall into the Income Investing Trap when you're
ready to start drawing cash from your portfolio for living expenses from your
portfolio. Just follow these three steps, and you'll boost your chances of
getting the income you need and lower the odds of running through your savings
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