This approach may initially generate the income needed today, but at the expense of growing the portfolio so it can meet spending needs later in retirement. Furthermore by reducing the diversification of the investment plan, the retiree unnecessarily increases its risk and reduces its tax-efficiency. The net effect of this strategy is to decrease, not increase the portfolio’s longevity.
The “total return method” will likely be a more effective strategy for most investors whose goal is to generate a sustainable income stream in retirement. With this approach, the retiree builds a diversified portfolio of assets that balances the need for current income with capital growth in order to meet spending requirements twenty, thirty or more years in the future. The investor then draws from the income first. If this proves insufficient to meet expenses, then the balance is taken from the principal.
This strategy requires that we overcome our instinct to “not touch the principal.” The reality is that money is money whether it comes from portfolio income or appreciation. In other words, it is the total investment return that matters and the source of that return is irrelevant.
Retirees face the challenge of converting savings accumulated over a lifetime of work into income that will last for as long as they live. With interest rates on income producing investments near historic lows, the task may be even more difficult today. Still, the fundamentals of building a sound, long-term investing plan remain unchanged: spend less than you earn, and invest sensibly in a diversified, tax-efficient portfolio that is consistent with your retirement goals.
John Spoto is the founder of Sentry Financial Planning in Andover and Danvers. For more information, call 978-475-2533 or visit www.sentryfinancialplanning.com.
This article is for general information purposes only and is not intended to provide specific advice on individual financial, tax, or legal matters. Please consult the appropriate professional concerning your specific situation before making any decisions.