How to Guarantee Income in Retirement

We all know — or think we know — that the older we get, the more our money should be kept safe. We gradually hold less in stocks and more in bonds. But is your caution risking your future? Yes, possibly. On average, we’re living longer and not earning much on quality bonds and bank CDs. If we huddle around investments that cannot grow, the risk rises that we’ll run out of money. What if we reversed the conventional rule and gradually held more money in stocks, rather than less, after we retired? It’s actually an approach that could make your retirement savings last longer and, potentially, leave more for heirs. So, how can you guarantee income in retirement?

Lower your risk

Think of it as a 3 bucket strategy.

In one bucket you hold cash to help cover expenses for the current year. That’s grocery money. Keep enough to pay bills not covered by other income, such as Social Security, a pension or part-time work.

In the second bucket, you own short- and intermediate-term bond mutual funds, with dividends reinvested. You gradually add to your bonds during your preretirement and immediate post retirement years. By age 60 or 65, these first two buckets might hold 70 percent of your retirement investments. Every year, you take money from the bond bucket to replenish your cash. If interest rates rise, you’ll be using your dividends to buy higher-rate bonds, which will partly offset your market losses.

The remaining 30 percent of your money goes into the third bucket, invested in mutual funds that own U.S. and international stocks. You don’t expect to touch these stock funds for 10 to 15 years.

As time passes and you sell bond shares to pay your expenses, that bucket shrinks. The percentage of savings that you hold in stocks will gradually rise. You won’t have to sell when the market drops. In fact, your dividends will be buying you more stocks on the cheap. By the time your bond bucket runs low, your bucket of stocks will have grown in value, maybe by a lot. That’s money for your later years.


Focus on growth

Wyatt Lee, portfolio manager for the mutual fund group T. Rowe Price, agrees that relying on “safe” investments won’t work. “You need a substantial amount of equities to maintain your income for life,” he says. Assuming a 30-year retirement, you’d spend half your money in the first 15 years and half in the second 15 years. The later money should be invested for growth.

Lee takes a more familiar approach — reduce your exposure to stocks as you age. But he starts out high. At age 65, he advises a stock fund allocation of 55 percent. Your 4 percent withdrawals would come from both stocks and bonds. At 75, you’d still have 42 percent in stocks. If a bear market hit just when you retired, you’d take a larger loss than with Kitces’ approach. You’d gain it back but might be more tempted to sell.

Either way, you can’t give up on stocks.

For more information, read the full article here.