Generating Income in Retirement

The goal of investing in retirement, when one is living off the investment account, is to generate enough income to pay for expenses so the principle can be left intact.  There must also be a growth aspect to the account to preserve the account value as it is ravaged by inflation and to keep the income level rising enough to keep up with inflation.  Ideally one would like enough cash to be generated from income and dividends to meet monthly expenses such that the sale of securities would not be needed.

This used to be a fairly simple thing (provided that the account was large enough.)  One could just select a set of dividend paying stocks such as utilities, buy a few bonds, and then collect the dividend checks.  One never needed to sell stocks to raise cash or touch most of the holdings at all.  When interest rates on bonds were in the 8-10% range, and stocks paid 5-8% dividends, one could easily generate $50,000 per year on dividends and interest with a million dollar account.

Unfortunately interest rates are currently too low to generate enough income to make this strategy work.  This is because the Federal reserve has lowered interest rates to near zero due to our real-estate bubble bursting, as the Japanese did in the 1980′s when their real estate bubble burst.  Unfortunately, we’re having about the same sort of luck the Japanese did, so interest rates may stay low a long time.

If interest rates do move back up, the typical retirement investments — those that pay a good dividend — are:

1.  Utilities – Because utilities are typically not in a growth phase, but instead simply collecting money from rate payers and distributing the profits to shareholders, utilities typically pay good dividends.

2.  REITs – Real Estate Investment Trusts hold a portfolio of real estate, typically concentrated in a certain type.  For example, there are REITs that focus on office buildings, apartment buildings, shopping malls, and even cell phone towers.  These generally generate good income from rents that are passed along to shareholders.

3.  Limited Partnerships – These trade like stocks and are typically tied to some income-producing source such as a big steel ore pit or a set of oil distribution lines.  Much of the income received is passed to the partners.

4.  Preferred shares – These are special shares of stock that a company issues when it wants to raise money for some purpose.  They typically pay a large dividend and can have special features like the ability to convert to common shares at some ratio.

5. Bonds – These are loans made to companies and pay interest twice per year and at some point in the future return the principal to the lender (the bond holder).  If interest rates do spike because inflation picks up, as it did in the 1970′s, one could be set for retirement by buying into bonds paying very high rates and then holding onto them as interest rates subside.  Bonds are currently paying too low a rate right now, however, due to the low-interest rates on government securities, to be worth the investment.

Because interest rates are low, one must be more creative to earn a return from a portfolio. Some options are:

1.  Continue to hold a set of index funds and sell some shares periodically to raise cash. This unfortunately requires selling stock and is subject to market fluctuations, but by keeping enough cash-on-hand to cover expenses for a five-ten year period, risk can be cut substantially.

2.  Write covered-calls to generate income from stock holdings.  This requires a bit of time since positions must be resent every couple of months, but can cause any stock to generate an income.  There are also some management companies that will perform this function for the investor.  Note one must be careful to maintain sufficient diversification while employing this strategy.

3.  Buy rental properties that generate rental income.  This is not the best option since it either requires one to become a landlord/repair man or hire a manager who will take a substantial amount of the profit, but it is a way to raise an income for those who enjoy real estate.  Fortunately, rents are currently fairly high since there are so many renters.

Comments appreciated! What are your thoughts? Questions?

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