No matter how large your portfolio is or how aggressive you’ve been with your stock- market plays, once you’ve retired your primary goal is no longer the accumulation of assets. They’re always nice, of course, but sometime soon (and perhaps it’s already happened) you’re going to have to replace paychecks. You need a financial advisor more than ever – ideally one who’s oriented to this kind of thinking.
You may have read our recent advice about picking a financial advisor. While I can’t recommend a particular consultant, I can let you know what a few savvy planners tell their clients who want to have a reliable income stream in retirement.
The first thing any planner will look at is your guaranteed income – the kind that comes from Social Security and pensions. If you don’t need the money right away, it’s generally a good idea to delay taking Social Security benefits as long as possible, since once you’ve claimed them, your checks are frozen at the level at which you started. There will be modest increases to account for inflation, of course. Remember that a retirement expert who knows the intricacies of the Social Security system can be of real value here.
If you figure out what you need to live on, and your Social Security and pension checks cover it, you’re home free, of course. You can leave you assets in cash or even play the market if you like, secure in the knowledge that your lifestyle is covered. Few of us are in that position, though; we need to decide how to invest our savings and other assets in instruments that will help us outrun inflation and provide a cushion when the unexpected comes along.
A Tempting Option
Opinions differ, of course, about which instruments to use. Annuities, where an insurance company often invests your money for you and pays you an agreed-upon stipend, are one option. But Tom Diem, a Certified Financial Planner and Chartered Financial Consultant in Fort Wayne, Indiana, calls them “very complicated products sold by unsophisticated people to unsophisticated people. The big selling point they hammer on is the word ‘guaranteed’ . . . Generally speaking, these are not a good idea for a person wanting income with the hope of having any money left for their heirs.” Why would anyone buy an annuity? According to John Graves, Editor of The Retirement Journal, “some folks just want a guarantee and not have to think about their money; these people may find a GMWB (guaranteed minimum withdrawal benefit) variable annuity the right fit. They get a fixed rate of return and a fixed income stream in x years.” But Graves makes no secret of why some advisors like annuities: “These beasts pay us significant fees and commissions.”
Things Have Changed
But making your own investment decisions “can be very tricky and dangerous.” as Rick Sabo, a financial planner from Pennsylvania, points out. “It used to be that you would invest your money in lower-risk income and bond funds and live off of that while trying to maintain principal. Now that people are living longer, financial planners must advise retirees to put more of their assets in higher-risk investments to outpace inflation . . . But you need to make sure you keep enough in fixed income to continue taking your monthly income without selling any of your higher-risk investments while the market is down.” How much can you safely withdraw from your investments? “People used to take 7% to 8% of their principal as income,” notes Sabo, “on the theory that they could go into the market and average that rate of return to maintain principal. Those rates are unrealistic in today’s market – you need to look at a 3% to 4% draw rate to maintain principal.”
“Inflation is the silent retirement killer,” says Jonathan DeYoe, CPWA. “Your income needs to increase every year, just to keep up with the rising cost of living. It’s not enough to calculate whether your portfolio will produce enough income this year. You must look at it to produce income for this year and enough growth to increase your income for next year – and every year beyond. If your portfolio is not increasing, your buying power and your lifestyle are evaporating. Your portfolio’s average growth rate must cover your withdrawals plus the inflation factor . . . If your first 3% – 4% of return is designated to continuous portfolio renewal so that your future self has the same income (buying power) as your current self and you withdraw 4% – 5% of your portfolio to meet current needs, you will need 7% – 9% in average annual returns to just barely maintain your buying power.”
One Advisor’s Strategy
Once Damian Rothermel, a Certified Financial Planner in Portland, Oregon, has taken note of a client’s assets, needs, and obligations, he creates a series of “buckets” to contain assets that will be invested to ensure a reliable income stream for a procession of five-year segments: five, ten, fifteen years, etc. – plus a couple of extra buckets for emergencies. Particularly for clients with a confusing variety of assets and a simple desire to live comfortably into advanced old age, this segmenting of assets lets the client understand how each one is contributing to the overall picture, keeping the less-exciting (but reliable) assets close at hand while pushing the riskier ones off at a distance where they have time to survive the ups and downs of the market without imperiling the client’s current lifestyle.
“Say for the first five years of retirement we anticipate the client will need $20,000 per year,” explains Rothermel. “I want to make sure that $100,000 is set aside, and I modify her assets’ current value to account for inflation, growth, and time elapsed to ensure that we meet that number. I then put her other assets into buckets for years 6-10, 11-15, etc. The investments in each five-year bucket typically move up the risk ladder because we have more time on our side. I also earmark dollars for specific purposes such as an emergency fund, health-care expenses, and a vacation fund.”
As Tom Diem says, “The income from a well-executed portfolio should rise nicely during retirement and leave a financial legacy for the investors’ heirs.” Organizing your assets so that your short-term needs are met while your principal appreciates to support you in the long run is the next-best thing to cashing a paycheck.
Fishbowl image via Shutterstock