While most people put a significant amount of time, effort and money into creating and nurturing a portfolio that will make retirement possible, few give much thought to how they will tap into their investments once retirement arrives. It's an issue worth considering, because just when you are ready to step back from the daily grind and relax, your portfolio needs to go to work. Here we give you some tips on how you can create cash flow during this important time in your life, setting yourself up for a comfortable retirement.
Identifying Your Needs
Before you start taking distributions and envisioning life at the beach, you need to make sure you have a solid grasp on the amount of money your retirement lifestyle will require and what percentage of that amount your portfolio can provide. Far too many investors choose a random number, such as $1 million, and assume that reaching that number is the key to a happy retirement.
While a cool million may seem like a lot of money, generous spending habits can make it disappear quickly, as the chart below demonstrates - and don't overlook the impact of inflation.
|Withdrawal $25,000/yr||Withdrawal $50,000/yr||Withdrawal $100,000/yr|
In the first scenario, $1 million will last for 40 years; in the second scenario, it will last for 20; and in the third scenario, it will last only 10 years. So, before you start spending, take a few minutes to determine the exact amount of money you will need to support your lifestyle, and then subtract the amount provided by Social Security, pension payments and other sources of income. The amount you are left with is what your portfolio needs to provide.
If your nest egg is significant, a portfolio growth rate that keeps pace with inflation may be sufficient. If your retirement income needs are great and your nest egg is not, your portfolio may be required to deliver substantial growth in addition to a steady income stream. Some common portfolios designed specifically for the needs of retirees are based on the following asset allocation models:
|Income Producing (Conservative)||0%||100%|
|Growth and Income||30%||70%|
As this table suggests, it is quite possible that your portfolio will include investments designed to seek income and investments designed to seek growth of principal. Since there are multiple ways to address each of these objectives, we'll discuss each one separately, beginning with income generation.
To create cash flow during retirement, most investors rely on payments produced by dividends, interest, annuities, systematic withdrawals from an equity portfolio, or a combination of these options. The selection of specific income-producing investments begins with a review of your tax situation, as taxes play a role in determining when and how much income should be taken in the form of distributions from 401(k) plans and other tax-deferred investments. If you anticipate a lower tax rate in the future, you may want to delay using your tax-deferred investments until a more favorable tax rate will apply. Where you choose to have your primary residence also plays a role, so if you are moving to a state that does not levy personal income taxes, you may also wish to hold off on tapping your tax-deferred investments until after the move.
When taxes are a major consideration, municipal bonds are attractive, as they pay interest that is exempt from federal - and sometimes state and local - taxes. If achieving the highest interest rate is more important to you than minimizing taxes, Treasury bonds may be a better choice. Both Treasury and municipal bonds are generally considered to be relatively safe investments due to their low risk of default. But keep in mind that the interest rates they pay are generally lower than those paid by corporate bonds.
Regardless of which bond variety you choose, a laddered bond portfolio can help to minimize some of the risks. In addition to directly purchased bonds, bond mutual funds also offer a range of investment options from conservative to aggressive and a choice of active or passive management.
Investors seeking to generate better returns than those provided by bonds generally look to the stock market. The inclusion of stocks in a portfolio offers the opportunity to generate not only dividend income (in the case of dividend-paying stocks), but also portfolio growth through price appreciation in the value of the shares. This growth potential can help a portfolio keep pace with inflation or help a small nest egg grow.
Blue-chip stocks and utility stocks are often included in portfolios designed to produce income. These stocks may pay an above-average dividend while exhibiting below-average volatility. Like bonds, stocks can be purchased in a variety of ways, including direct purchase of securities or via mutual funds which offer a choice of active or passive management.
Cash and Cash Equivalents
As a supplement to bonds, or as an alternative to them, some investors choose certificates of deposit or money market funds. These investments are often referred to as "cash equivalents" because of their high liquidity. A good rule of thumb is to maintain enough cash on hand to purchase a new car, since that tends to be the largest expense you are likely to face in retirement, if you have full medical insurance coverage.
Putting It All Together
The portfolio that helped you reach retirement may not be the one you need to sustain your retirement, and determining the exact proportion of stocks and bonds that is appropriate for your retirement portfolio can be a challenging exercise.
If you have concerns about your portfolio's ability to sustain your income needs, you can always consider part-time work. If that's not appealing to you, or not an option, a reverse mortgage provides another avenue to explore. Tapping the equity in your home can add a solid and predictable source of funds to any portfolio.
The Bottom Line
People today are retiring earlier and living longer than any previous generation, so a careful evaluation of your financial situation is a critical part of retirement planning. The anticipated length of your retirement, the need for asset growth, the income requirements of your desired lifestyle and the impact of taxes all must be examined. If you are not confident in your ability to find the right combination of investments to strike that perfect balance between your risk tolerance and your income needs, consider consulting with a professional financial advisor. At this stage in your investing life, attention to detail and careful planning are the keys to a long and happy retirement.