Retirement Investing: How To Guarantee Yourself A Regular Income Check

Unfortunately, very few of us have access to pension plan which will provide a regular check for a fixed dollar amount when we retire.  We may be entitled to Social Security, but the small size of the check may still force us to rely on our savings and investments to cover expenses.

How does one generate that monthly check?

The fantasy for many people is to live off the income and gains made on their investments. Unless you are very rich, this is probably not possible with interest rates being so low and the stock market being so choppy.

The remaining answer is to pay for your living expenses by taking funds out of your investment portfolio.  The danger is by going into your nest egg,you may eventually be left with nothing.  A good financial planner can help you do the math and figure out the most that you can take out per year and still have your funds last to a certain age.  Here are our thoughts on the subject:

Different Approaches To Generating A Regular Check

Buying Individual Bonds – When 10 year high quality municipal bonds paid 6%, you could generate $30,000 in tax free income per year with a $500,000 investment.  However, you will not even earn half that amount today.  With today’s low yields, even if you buy high quality taxable corporate bonds, you will not earn $30,000.

Buying Bond or Stock Funds – Both stock and bond funds provide income/dividend distributions. Typically, stock funds make quarterly or annual distributions.  Most bond funds pay out income monthly.  However, even for bond funds, the amount of these distributions vary greatly.

Invest Normally And Take Out A Set Amount Every Month –  Investing with the goal of generating a minimum amount of income can lead to some very strange investment choices. For example, you might invest solely in junk bonds (which are extremely risky) or  high-dividend stocks (which tend to be slow growth) to maximize income. Instead, the focus of your investment should be creating the highest total return (appreciation + income) rather than income.

From a financial perspective, the $ amount of the withdrawal from your account is what matters. It does not matter if that amount is derived from principal, income, or investment gains.  However, from a psychological perspective it does. “I am going to live off interest and dividends” is a powerful emotional statement.  “I am only going to take out $x,xxx per month,” does not have the same forceful ring.  And, it might be tempting to increase that amount by $500 or $1000. These small extra withdrawals over a few years can destroy a portfolio.

Embrace A Laddering Strategy – A laddering strategy is simplest form of investing in fixed income instruments (CDs, bonds) that mature at regular intervals. Traditionally, with a laddering strategy you reinvest funds as they mature.  However,  when you need to live off your savings you can create a ladder which provides income for 5, 10, 15 or even 20 years.  Instead of reinvesting assets as they mature, you can put them in savings to pay for living expenses.

There are three major benefits to a bond ladder in this case:

  1. Psychologically, it requires less discipline than withdrawing a fixed amount every month.
  2. You will know exactly how much money you will be receiving in the future.
  3. On money which you don’t need until far into the future, you will be able receive a higher yield by committing to investments with longer maturities.

The Drawback – If high inflation returns, your investments will not provide you a positive real return. In other words, if you subtract inflation from your returns, the number will be negative if inflation moves beyond its current 2 – 3% range.

What’s the bottom line?

Focusing your investment strategy on generating the highest total return (income + capital appreciation) that is within your risk tolerance is the recommended method for most people.   However, if you are not comfortable putting principal at risk, then a laddering strategy with CD’s and/or bonds is best.  You can learn more about that here and here.

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