Getty Images When people get serious about retirement planning, they often buy bonds. That's because fixed income provides shelter from rocky stock market returns, offers stable income and a return of your capital if you wait long enough (and if the company that sold you the bonds stays in business).Those characteristics do indeed describe bonds. But if you're retired, you still need to think twice before buying bonds. Rates are low today, and bonds won't help combat inflation -- the arch-enemy of every retiree. If you are willing to tie your money up for 30 years, you can earn a little better than 3.25 perecent with Treasury Bonds, as of Sept. 22.
That's just not enough for most people to live on. If you are willing to ratchet up the risk, you can earn a bit more -- but not a lot more -- with corporate bonds. Fortunately, retirees can use equity growth to boost your monthly cash flow by a third or more.
How Does It Work?
This is a v! ery simple process:
- Invest a portion of your nest egg in an equity growth or balanced portfolio.
- Withdraw 4 percent of your account value each year.
- Readjust your withdrawal amounts each year based on your new year-end balance. If your account grows, your income will increase, too. If your account values drop, you'll have to reduce your annual withdrawals.
What If Your Portfolio Doesn't Earn 4% In Given Year?
Forget the "what if." I can guarantee there will be years when equity won't deliver the minimum 4 percent. To make it worse, there will be years when this investment approach will lose money -– sometimes a lot. What do you do then? Stick to the plan. One year does not a retirement plan make.
This is a long-term proposition. Sure there will be years that show losses. So what? The odds are that there will be plenty more years that make up for those bad years and then some. Even if you are 65 on the day you retire, you still have 20 to 30 years ahead of you (hopefully). And you will need your capital to create retirement income for as long as you live.
People want to have stable investments but need income that will last all their lives. And what they need is an income stream that will grow to offset inflation. You don't get t! hat with bonds. But you have that potential with equity growth.
How Do I Know That My Portfolio Will Sustain 4% Withdrawals?
We are talking about making investments today that will grow until you retire. Then once you retire, those investments have to create income for at least 20 or 30 years after that. When you talk about an investment timeframe of that length, it's hard to be certain about anything. Having said that, let's look at the research.
The most widely cited (but still controversial) research into safe retirement withdrawal rates is the Trinity Study. It concluded that a portfolio with at 50 percent to 75 percent allocation to equity has the highest probability of providing inflation-adjusted income for a retirement lasting 30 years.
Some argue that this withdrawal rate is too high, and others argue that it is too low. That's why I suggest that you adjust your annual withdrawals based on year-end va! lues. This reduces your risk.
W! hat Happens When the Market Drops?
When the market drops. your account values will likely drop, too. That means your income will take a hit as well. I realize that nobody likes to see their income drop, but we have to weigh the alternatives. And fixed income as a long-term alternative doesn't cut it. The Trinity Study proves that.
A few years back I ran a hypothetical retirement income plan based on investing $100,000 in 1988 in the S&P 500 (^GPSC). I studied withdrawing 4 percent of the value each year no matter what. If you look at the chart I created, you'll see that there were years when the income dropped –- sometimes significantly.
But from 1988 through 2011, the hypothetical investor saw his or her income increase from $4,000 a year to more than $14,000. That's more than a 300 percent increase, and no bond can deliver results like that. Of course, the past is no guarantee of the future -- and you can't invest directly in the S&P 50! 0 -- but you get the idea.
Retirement income is a long-term proposition. So you have to think about your income and your capital over the long-run. What happens this year or next really isn't that important. Using equity growth to fund your retirement is a wonderful way to immediately bump up your monthly check. It's also a great option for people worried about long-term inflation -- and that should mean you.
It isn't perfect, and there are no guarantees. But if you think about your retirement and the pros and cons of each investment option, I think you'll agree that equity has a place in your portfolio. Are you using equity to provide income? Why or why not?
Source : http://www.dailyfinance.com/2014/09/23/boost-retirement-income-easily-significantly/
