Investing to Generate Income in Retirement

This is the next post in a series on life-long investing strategy.  The series starts here.

If you started investing in your early twenties or thirties and have been following the advice of this blog, you should have gained financial independence at about age 45.  At that point you should have had enough money in investments to replace the income from your job – somewhere between $750,000 and $1.5 million dollars.  From that point your portfolio should have continued to grow (since you kept your job, or at least found another that you really liked) and therefore didn’t withdraw much of the interest from the investments.  Hopefully though you did take some of the money to improve your house, take some nice vacations, and otherwise live life.  Even with a little lifestyle mixed in, you should have between $10 million and $15 million by now.

 At this point, since you’ll be living off of your savings, you’ll need to be generating income and selling assets as needed.  A good rule-of-thumb is that you can take about 8% each year from an account without the balance declining over the long-term.  You can take 10-12% if you don’t mind seeing the balance decline.  For example, if you do have $15 million and would rather spend some of it than leave it to your heirs.

Because you cannot tolerate risk, you must keep the diversified portfolio, with maybe a little money concentrated in growth stocks.  Set the portfolio up so that you receive enough income to not need to sell shares very often (although if taxes on interest are high compared to capital gains, it may be better to sell a few shares here and there to gain living expense money).  Good choices are blue chip stocks, REITs, investment real estate, utility stocks, and drug companies.  Make sure you have spread funds out to guard against devastating events, like fraud, bank collapses, etc…, because these are the only risk you really will be facing.

If you have less assets than you would like, you should still have the diversified portfolio to preserve what you have.  Unfortunately you’ve lost the luxury of time, which reduces the risk of being more concentrated.  You should also have sufficient assets liquid (in
a savings account) to pay for expenses for at least 5 years since you won’t be able to sit through market downturns since you’ll need
your portfolio for living expenses.

Because interest rates currently are very low, it is very difficult to generate the interest needed to sustain the value of the account from interest and dividends alone.  It is therefore likely that you will need to sell some stocks and make money from capital gains.  Because the rate of return from capital gains is not steady, the best thing to do is to sell more when a good year has occurred and then sell less or none at all when stocks have not done well or declined.

For example, the market has an average rate of return of about 10-15%; therefore, one might set a target rate of return of 12%.  After raising 5 years’ worth of cash (money markets, bank CDs, etc…), if the market returns more than 12% in a year, sell enough stock to have enough cash for 10 years.  If the market declines or achieves less than a 12% return, sit pat unless you have less than 5 years’ worth of cash.  In this way you will be selling when stocks are high and you have a good return and will be holding while stocks are down.  Some years the market may be up 30% and you’ll sell to gain cash.  Other years it will decline and you’ll just live off your savings.

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