19 June 2019

The Best Way to Invest for Retirement Income

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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 they age.

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 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. 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 withdrawal rate. 

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 too soon.

Click here to access the full article on CNNMoney.

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