Plans and goals for retirement may vary from person to person, but there is one thing most everyone wants during their retirement years: peace of mind. You want your retirement to be as stress-free as possible, specifically when it comes to money. But how do you achieve that goal?
The answer boils down to one word: income. Most financial advisors won’t tell you that because most don’t specialize in income-first investing. As Income Specialists, we know there are seven secrets of a stress-free retirement, and that they all start with making an important shift shortly before you retire or soon after.
1. Let the Math Be Your Guide: TR=I+G
Although math can be complicated, our secret is based on simple math, specifically the equation TR=I+G, which stands for total return equals income plus growth. Many people think of growth and return as meaning the same thing. But total return is a sum of two things: growth and income. Growth is measured in capital appreciation, while income is generated through interest and dividends. Whenever you invest, you’re likely getting return from both sides of the equation, but many people only focus on the gains because their strategy is geared mainly toward achieving growth. Income is secondary.
That’s fine when you’re young. Investing for growth makes sense when you’re in your 30s and 40s because retirement is still a long way off and your top priority is to grow your savings. Also, whenever you’re investing long-term, focusing on growth is smart because you can dollar-cost-average, which is a strategy that helps you buy low whenever the market is down so your money grows faster once the market recovers.
But all that changes as you get closer to leaving the workforce because once you do, you’ll need your investments to serve as your primary source of income. That being the case, doesn’t it make sense to shift your strategic focus from growth to income? In terms of pure logic, it does make sense for most people but, again, it’s not what most financial advisors will tell you. Because most advisors don’t specialize in income-based strategies, they simply don’t talk about that strategic shift or how important it is. Instead, many still recommend the approach of “engineering income” through a withdrawal plan.
You’ve probably heard of the 4% withdrawal rule. It says if you have a million-dollar stock portfolio, you should be able to safely withdraw $40,000 a year for life and be reasonably sure you won’t run out of money. But what does “reasonably sure” mean? The answer often boils down to having about an 80% chance of your money lasting for as long as you need it. That, of course, means you also have a 20% chance of running out, and that’s a best-case scenario.
The point is that withdrawal plans are flawed because they’re based on a huge unknown; they depend on market growth, which you can’t always count on. Sometimes the market experiences long periods of no-growth, which has happened twice already since the start of the century, starting in 2000 and again in 2008. Therefore, if you were using a withdrawal plan to engineer income from 2000 to 2013, you were actually reverse-dollar-cost-averaging. You were selling low, thereby cannibalizing your principal and increasing your risk of running out of income with each passing year. Does that sound like a good formula for a more stress-free retirement? Of course not.
Now imagine you had shifted your investment focus from growth to income-first sometime just before or shortly after the year 2000. Imagine you had that same million-dollar stock portfolio but were using a strategy designed to give you a 4% annual dividend yield, and that’s what you used for income. Yes, your account would still have dropped during those 13 years, but by the end of it, you would have gotten all your money back. Why? Because making that strategic shift would have allowed you to maintain a sufficient and reliable income stream without ever having to touch your principal!
- Modernize Your Financial Strategy for Your Stage of Life
So, when exactly is the best time to make this important shift? The first part of the answer depends on your stage of life. When you’re in your 20s, 30s, and 40s, you’re still in the growth and accumulation stage. As noted, your top priority during those years is to grow your portfolio for retirement. Once you get into your 50s, though, you’re in a transitional stage; you still want growth but you also know that within 10 to 15 years you’ll need your investments to start generating sufficient and reliable income. Then, at some point during your 60s, you’ll most likely fully enter the income stage, where your savings will be your primary source of income. The second part of the answer is “the sooner the better” once you’ve entered the transitional stage so you can avoid getting caught in the next big market downturn, which is always a possibility. As a rule, we recommend making the shift within 10 years of retirement, but it’s never too late!
- Understand the Benefits of an Income-First Approach
Once you make the shift to an income-first strategy, there are three main benefits:
- One: You increase your income return. You get more income from your investments because that is now your strategic priority. It’s that simple.
- Two: You decrease your risk. We’ve already discussed that in one respect by showing how an income-first approach reduces your risk of cannibalizing your principal. Also, keep in mind that when you’re investing for income first you’re typically investing in a lot of things like individual bonds and bond-like instruments, which are designed to ensure the return of your principal if you hold them to maturity. That essentially means any loss due to volatility is just a paper loss, and meanwhile, your income return is unaffected.
- Three: You get more growth potential. This one comes as a surprise to most people but it’s true. Even though your focus on growth is now secondary, you can still get more growth potential through strategic reinvestment. Historically, stocks that pay dividends have paid a 50% higher average annual return over the last 40 years versus non-payers.
So again, more income and growth potential with less risk. Does that sound more like a formula for a stress-free retirement? You bet it does!
- Beware of Mutual Funds in Retirement
This one also surprises some people. After all, mutual funds are your friend during your growth and accumulation years. They help you to diversify, which is important, and to dollar-cost-average. But they also have features that make them not only less helpful during your retirement years — but downright counterproductive.
For one thing, studies show that most stock mutual funds underperform the markets for many reasons. One of the biggest reasons is fees, many of which are hidden and can greatly diminish your returns, especially in a down market.
What about bond funds? Well, first you need to understand that when you buy an individual bond, you get two important assurances. First, you get a fixed interest payment for the life of the bond. Second, although the value of the bond can fluctuate, once it matures you are guaranteed by the bond issuer to get back the entire face value of your investment (provided, of course, that the issuer does not default). As already noted, this basically means that any loss in your bond’s value due to market volatility is just a temporary paper loss, and your income return is unaffected.
When it comes to bond funds, however, both of those assurances are off the table: there is no fixed interest payment and no guaranteed repayment of your principal. Ultimately, bond mutual funds carry many of the same risks and shortcomings as stock mutual funds, including hidden fees. Here again, though, most advisors don’t tell you this because, since they’re not income specialists, bond funds are the only “conservative” strategies they’re qualified to offer.
- Be Ready for Your Required Minimum Distributions
Starting at age 73, you’ll need to start taking required minimum distributions (RMDs) from all your qualified retirement accounts. These IRS-mandated withdrawals start at almost 4% and increase as you get older and your life expectancy decreases. Failure to take your RMDs properly or on time could result in a tax penalty. But what is the most important thing you need to know about your RMDs?
It concerns the question: Where does your 4% RMD payment come from? If you’re still invested for growth and getting a dividend yield of only 1.5% or so, that means the other 2.5% of your RMD needs to come from growth: from the “G” side of TR=I+G. But, once again, since you can’t count on growth, what you’re doing potentially is spending down your principal.
What’s the better option? To invest for income and get the entire 4% from income. That way, you won’t need to risk taking anything from the principal. That’s great, of course, but it gets even better because now imagine you could get 6% from the “I” instead of 4. That means, potentially, you could take that extra 2% and reinvest it. So now you’re not only preserving your principal but you’re getting more growth!
- Why Smart People Roll their 401(k)s over to IRAs
Maybe you’ve already rolled your 401(k) over to an IRA, or are at least thinking about it. Good. But why is this such a smart thing to do? Well, the reason most employers offer 401(k)s in the first place is because they want to attract and retain young talent. A 401(k) isn’t meant for older investors. You can leave your money if you want, but what are the drawbacks of doing that?
Well, if you leave it, you may have rules that restrict your access to it. Plus, your investment options might be limited to mutual funds, which we’ve already talked about. Also, you’ll have limited distribution flexibility for your children and grandchildren if you should die, and you can’t do a Roth IRA conversion. Finally, you have very few income-based options in a 401(k), which, again, are primarily meant for younger investors.
On the flip side, rolling your money over to an IRA means you can still grow it tax-deferred, just like in the 401(k), but you can control better where it is invested. Also, you can do Roth conversions, and you can better control market risk because you have the full universe of income-first investment options to choose from.
- Never Stop Learning
The final secret to a stress-free retirement is one you’re already aware of because you’re reading this. Never stop learning all you can about investing and the financial markets because, again, most financial advisors won’t tell you everything you need to know. They’ll tell you only what suits their business model, but the reality is that your options are far broader than what most advisors can provide!
So, stay informed, stay educated, and know that a more stress-free retirement is possible, and that — based on our experience and expertise — the seven secrets to it all boil down to one word: income!