Where to Find Income in Retirement?
Question: What do you recommend for income in retirement? I’m retired and need income from my investments.
Answer: Nobody wants to run out of money, especially when you’re retired and won’t be able to earn it back. Retirees need income to live on and support their lifestyle for the rest of their lives, and our lives keep getting longer. So how does a retiree invest their portfolio in today’s economic environment to provide them the income they need?
It’s not easy. There are several obstacles in the way. Interest rates are at all-time lows. Two-year Treasuries are paying under 1%. 10-year Treasuries are hovering below 2%, 30-year Treasuries below 3%, and AAA corporate bonds around 2.5%. Stocks aren’t helping much. The U.S. stock market, as measured by the S&P 500, is paying a little over 2% per year in dividends.
Okay, it’s apparent that in today’s economic environment retirees can’t live on interest and dividends alone unless they are ultra-wealthy. So what about making money by buying and selling stocks? Well, first of all most of us know that most stock traders, especially amateurs, lose more money than they gain. They don’t have crystal balls, and they can’t consistently pick superior stocks. If you own a few stocks, they might go up but they might also go down, and you are exposed to the risk that the company or companies you own won’t do well.
For example, if you own Chevron (CVX), you might be getting a 4+% dividend today, but your stock is worth around 15% less than it was a year ago. And maybe you bought Kinder Morgan (KMI) for a nice dividend, but last year when oil prices dropped KMI’s price decreased from a high of near $45 to around $18 today, and they lowered their dividend by 75%. That’s company risk, and you won’t see it coming.
On the other hand, a mutual fund that represents the S&P 500 is very likely to increase in value over time with no company risk.
What’s the answer? Institutional endowments for colleges, universities, community foundations, and other non-profit organizations are meant to be around forever and produce annual income for charitable purposes. Most of these endowments are managed by experienced professionals. Normal spending rates are usually between 3% and 5% per year. In California, a spending rate higher than 7% is considered to be presumptively imprudent. To make a 4%-5% spending rate, pay fees, and keep up with inflation, endowment managers need expected returns of 6-8%.
For retirees who want their portfolios to last for the rest of their lives and spin off 4% to 5% of spending money a year, they too need expected returns of 6%-8%. So if retirees want to learn from endowments to help them meet their income goals, they should look at how endowments allocate their portfolios.
Mutual funds and ETFs allow retirees to have portfolios very similar to smaller endowments. A portfolio diversified across asset classes and invested in U.S. and international large and small company stocks and bonds, with some exposure to REITs and maybe even commodities, can be tailored to suit your risk tolerance and return objectives.