Q: I have been working and saving for retirement for the past 50 years. My goal was to retire once I had a million dollars in retirement savings and I am almost there. I thought a million dollars would surely be enough to support my wife and me for the rest of our lives. Now, with interest rates so low, I don’t see how it will work. I am 70 years old, and I don’t want to keep working. Any ideas?
A: A million dollars sure isn’t what it used to be, especially when it comes to building an income-generating portfolio. This is the downside of living in a world of low interest rates. Low interest rates may be great for businesses and consumers, but they punish savers—especially older savers—who are looking to create an income stream in retirement.
Before you do anything else, I strongly suggest you work with a competent financial planner to develop a retirement plan. A retirement plan will do three things for you. First, it will help you know when you can safely retire. Second, it will help you know how to structure your portfolio to best meet your income needs in retirement. Finally, it will help identify and evaluate potential hazards you will face in retirement, like the need for long-term care.
Given today’s low interest rates, you probably need to think about portfolio income differently than you did in the past. For example, many people still think about portfolio income in terms of dividends and interest, but that really doesn’t work. Back in the 1980s, a million-dollar portfolio allocated with 60 percent in U.S. stocks and 40 percent in U.S. Treasury Notes would have produced annual dividend and interest income of about $68,000. That same portfolio mix today will only produce about $13,000 a year. To make matters worse, the cost of living has more than doubled since the 1980s. In other words, in real terms, dividend and interest income is only about one-tenth of what it was in the 1980s.
The solution is to think about your portfolio in terms of total return. Total return is simply income return (i.e., dividends and interest) plus capital appreciation. Most professional money managers, including those who run large retirement plans, always think in terms of total return.
The shift to total return thinking can be challenging. Income investors generally favor steady and consistent returns so they can meet their budget expectations. Unfortunately, total return is anything but steady and consistent. In fact, a portfolio’s market value can change dramatically from year to year. For example, in the 1980s, the annual change in market value for the S&P 500 averaged 13.1 percent per year, but ranged anywhere from down 10 percent in 1981 to up 27 percent in 1989. The S&P 500 has behaved in similar fashion over the past 10 years with annual returns ranging from down 6 percent in 2018 to up 30 percent in 2013. The average annual change in market value for those ten years was 13.8 percent.
So how do you make the change to total return? The most effective way is to establish a spending policy for your portfolio. This is the approach used by most institutional portfolios and it also works for individual portfolios. A spending policy is a set of rules that stipulates how the portfolio will distribute assets to meet the needs of the investor. The simplest spending policies require the portfolio to payout a certain percent of the portfolio each year. The payout rate is usually set comfortably below the portfolio’s expected long-term return. A more complex policy might require the portfolio to distribute a percentage of the portfolio’s assets based on the portfolio’s total return for the previous three years. A well-designed financial plan can help you identify a spending policy that balances the portfolio distributions you need today with the goal of making your portfolio last for the rest of your lifetime.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have about investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to