Paycheck Replacement is the Key Issue in Retirement Investing For Most of Us
For most of us, our working years are built around earning paychecks to pay for the necessities and luxuries of our life, so paycheck replacement is the key issue in retirement investing. Paychecks create confidence that we’ll be able to pay the bills, buy groceries, go on vacations, and generally live a comfortable life.
And when it comes to retirement investing, dependable income becomes the key issue. Just because we stop working doesn’t mean our expenses stop, after all.
While regular “paychecks” from Social Security are part of the solution for income replacement in retirement, much more will be required to continue providing for anything above our most basic necessities. You may be fortunate enough to have a pension too, but you will still likely need additional income from your retirement investing to support your desired standard of living.
Building a Stable Portfolio for Paycheck Replacement is the Key Issue in Retirement Investing
When developing your retirement investing plan, be sure the risks embedded in your portfolio are appropriately budgeted to account for a bad run of events. Remember that your investment returns are made up of two different return sources: income from dividends and interest, plus or minus capital gains or losses.
On average, the stock market goes up and creates gains two out of every three years. Of course, the corollary is also true. On average, the stock market declines and creates losses in one of every three years. So, you’ll need to account for this. It’s also important to recognize that an average experience is not every experience. There have been times when the stock market has declined two, and even three, years in a row.
It’s important you recognize that these negative return years are not the result of an underperforming manager. These are years where the returns of the unmanaged stock market (S&P 500) are just negative. This is just in the data set and you’ll need to account for it in your retirement investing plan.
This risk of a bad run of events is also referred to as sequence of return risk ― the risk that the number and magnitude of negative return periods could cause catastrophic portfolio failure, resulting in premature portfolio depletion.
If you are not well-versed with stock market history, you will be well-served to seek retirement investing advice from an experienced and well-educated and well-trained fiduciary fee-only financial advisor, not an individual selling financial products.
Portfolio Construction and Paycheck Replacement is the Key Issue in Retirement Investing
Be sure your retirement investing strategy is designed to help account for the periods of falling securities prices that inevitably follow the periods of rising prices.
None of us can count on repeated annual gains from rising security prices to make our ends meet, so you’ll need to examine whether your dividends, interest and other income sources will be adequate to meet your monthly cash needs when the markets experience their unavoidable periods of price declines.
There are two important keys to successful long-term income replacement in your retirement investing strategy. The first is to avoid large losses ‒ what we commonly refer to as “wipe-out risk.” Big realized losses combined with withdrawals to meet regular expenses can create a reverse snowball effect, rapidly depleting your capital and increasing the odds that you’ll outlive your money.
This scenario leaves you with two options that are equally unpalatable: Living less comfortably or – if it’s even possible – returning to work.
The second important key to successful long-term income replacement is the ability to generate consistently rising income. It is highly likely that your expenses will continue to rise during your retirement.
When you stop and think about it, how many costs do you have now that have not increased during the past 20-30 years. Probably not very many, and certainly not enough to feel comfortable about living on a “fixed” income for the next few decades.
Fixed annuity payments may help create more reliable income during the early years of retirement, but in the longer run, fixed annuities may not successfully address your rising costs and expenses. Annuities can also work against your estate planning goals.
The challenge for all of us is to build an investment portfolio that helps us to “eat well” and “sleep well.” That’s especially true in retirement, where we no longer have work income and consequently have a lower margin for error.
Retirement portfolios must generate enough income to allow us to eat well and live comfortably in general. But they must be stable enough so that we don’t lose sleep over our fear that we’ll lose our savings.
Striking that balance is essential and much easier to accomplish than it has been for nearly 15 years. U.S. Treasury securities and investment grade bonds have recently started offering 4 to 5% yields again, enabling you to build portfolios that generate higher levels of predictable income and still sleep well.
Paycheck Replacement is the Key Issue in Retirement Investing for All of Us
Cash flow is the oxygen of financial life for all of us. If you would like help building a portfolio of high quality, publicly listed stocks and bonds designed to generate rising income, capital growth and price stability better than an unmanaged stock market index might provide, without using annuities, we may be able to help.