How do I Create an Effective Retirement Income Strategy?

People planning for their retirement face some big questions.

The ones we most often hear include:

  • “How much of a ‘paycheck’ can I pay myself in retirement?”
  • “What if that paycheck isn’t enough to cover my expenses over time?”
  • “How can I ensure that I don’t run out of money?”

How-Do-I-Create-An-Effective-Retirement-Income-StrategyThese questions highlight the conflicts, concerns and tradeoffs faced by investors as they transition from their working lives into retirement. For instance, it may seem like eliminating investment risk is the best way to ensure you will not run out of money- but focusing too much on safety can actually be detrimental. At the same time, investing aggressively for long-term appreciation means accepting volatility that is uncomfortable for those in or near retirement. And focusing too much on income (especially in today’s low yield environment) often means taking on higher risk- and increasing your anxiety rather than reducing it.

Enter the process of Retirement Income Planning. Retirement Income Planning uses Financial Planning and Investment Portfolio Design to gauge your situation and resources, look at your goals, objectives and spending needs, balanced by your willingness or ability to take investment risk. The result is an investment and income plan to address these big questions, putting your mind at ease as you deal with other aspects of the transition into retirement.

Income and Safety

In “The Good Old Days,” retirees often had a reliable combination of stable income in the form of pensions and Social Security, a portfolio of safe bonds or dividend-paying stocks that generated predictable income, and perhaps most importantly, a modest life expectancy. (Shorter life expectancies meant that life savings didn’t need to last as long as might be required now.) Furthermore, risk-free investments like CDs and Treasury bonds offered relatively high yields compared to the current low yields.

Today’s retirees face a more challenging environment. For one thing, reliable pensions are going the way of the Wooly Mammoth. For another, secure bond income is paltry and “zero-risk” income almost certainly won’t be enough for most retirees to live on.

Longevity and Inflation

Today’s retirees face a high probability that they will live long lives- and so will need their money to last for many years. Today’s 65-year old has high odds of living past age 90. In fact, for married couples, the odds are steadily increasing that at least one will live into their 100’s. The biggest challenge to maintaining your lifestyle over long time periods is inflation. Like water carving a canyon out of solid earth, inflation steadily erodes purchasing power over time. At 3.2% inflation (the average since 1929), the cost of living doubles over an average retirement from age 65 to 87. For retirees depending on fixed pension or annuity payments that don’t increase with inflation, it becomes more and more difficult to maintain the same lifestyle over a full retirement.

Risk and Volatility

Today’s retirees know all too well that investing for long-term growth comes with volatility. More recently, they have also been faced with the challenge of generating stable, predictable income in low-risk, low-yielding securities. In order for a retiree’s nest egg to keep up with inflation over 20 or 30 years, there has to be some growth in addition to current income. Historically, the best asset for long-term growth and inflation protection is stocks. However, while a portfolio loaded with stocks may have high expected returns, it also comes with a lot of volatility.

If your money can sit indefinitely and float with the stock market’s ups and downs, volatility isn’t much of a problem; it can even create opportunities. For retirees that need to withdraw from their nest egg to provide a retirement paycheck, volatility means risk: the risk that you will deplete your portfolio by selling investments during down markets, in order to provide for the withdrawals. Volatility also creates anxiety, and can cause long-term investors to make costly mistakes, such as selling their stocks at depressed prices.

Clearly, the defining question for retirees is how to balance current spending needs with the long-term risk that their assets don’t keep up with their cost of living.

Balancing the Conflicting Needs

A well-designed retirement income plan should balance the requirements of providing current income with the need for long-term growth and the ability to withstand market downturns without depleting your retirement nest egg. Doing this requires a disciplined and thoughtful investment strategy that balances growth and income investments. Both portions of the portfolio contribute to the goal of generating a sustainable withdrawal over long periods of time. Traditional concepts of retirement (buying bonds and living on the income) are less relevant in today’s investment environment than are modern concepts of total return investing.

The Sustainable Withdrawal Rate

Balancing the competing needs of income and growth while controlling risk means putting some limits on the withdrawals your investment portfolio must provide. Many academic studies of a “safe withdrawal rate” have centered around a rate of 4% per year. This rule of thumb has arisen from early research, and like most rules of thumb, includes many problematic caveats.

Sustainable Withdrawals And Your Lifestyle

Understanding your personal withdrawal rate requires financial planning What is your situation and your resources, what specific risks are you faced with, and what are the objectives you want to achieve? Few retirees are able to meet all of their goals without prioritizing some over others, allowing for compromises and occasionally some tough decisions. For example, if travel, a comfortable home, and support for family members are all high priorities for you, and heavy withdrawals are needed to pay the expenses of a view home in coastal Southern California, moving to a less-expensive home may be in order.

Furthermore, many retirees want to leave behind a legacy, whether it’s an endowment for charity or a nest egg for family. This is a critical component in the financial planning process because it can have a significant impact on current spending.

Creating an Effective Income Strategy

Clearly, there is a lot that goes in to creating an effective Retirement Income Strategy. By going through the Retirement Income Planning process, you will be able to determine an income that you can feel confident will last for your lifetime.

About Jon Beyrer

Jon Beyrer, EA, CFP® is a partner of Blankinship & Foster LLC and is the firm’s Chief Compliance Officer. As a lead advisor, he focuses on helping families achieve their goals with sound wealth planning. In the community, Jon serves on several boards and is co-founder of the Professional Alliance for Children, a legal/financial charity for families of ill children. He has been quoted in The Wall Street Journal, The New York Times, and the Journal of Financial Planning. Jon lives in San Diego with his family.

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