Retirement investing used to be so simple. Retire at 65, buy bonds and live off the interest until you died, which was probably in about five to 10 years. Just set it and forget it.
Things have changed. Investment grade bonds no longer yield 8%. Today a 10-year Treasury bond gets you about 2.3%. Unfortunately, you probably can’t live off a 2.3% yield unless you’re worth several million.
That’s just the start of today’s complications. Ironically, increasing longevity makes it harder and harder to fund a lifetime of income. The longer you live, the more money you need.
Forget Living Off the Interest
The reality is the idea of living off the interest is gone; maybe not forever, but certainly for the foreseeable future. Rates may increase in the next year or so, but probably not enough to let you live off the interest.
In other words, you’re going to have to dip into your principal for current income. This is a difficult realization for some clients. Moreover, you’re going to have to take on some risk with investments in equities to generate long-term growth. If you don’t, you’re probably going to run out of money, unless you’re worth a boatload. Ironically, in this sense, investing equities actually lowers your overall risk by extending the life of your portfolio.
A 7-Step Process
Making your money last in a 2% world demands sophisticated planning. You will need to invest with great discipline, taking advantage of potential gains and rebalancing effectively after market declines. The most challenging step is to calculate your portfolio withdrawals in a way that meets your income needs, yet enables your portfolio to last through your lifetime. Each step is critical. Miss one and you may miss your goal. Here are the 7 steps:
Plan Your Retirement: Examine your priorities and make a plan for retirement.
Create a Financial Plan: Incorporate your plans for retirement and make sure the costs fit. Use your financial plan to set your target return.
Determine Your Portfolio Allocation: Based on long-term data, select an asset allocation of stocks and bonds that can reasonably achieve your target return.
Invest with Low-Cost Investment Strategy: Invest in low-cost stock and bond ETFs (exchange-traded funds) to broadly diversify and keep taxes low.
Manage Long-term Portfolio Risk: Avoid emotional trading. Turn volatility into opportunity by capitalizing on declines to buy bargains.
Calculate Your Portfolio Withdrawals: Use high-end software to determine withdrawals and adjust your spending budget if necessary to make it fit.
Monitor, Revisit and Update: Monitor your progress and update as needed to stay on track.
Living in a 2% interest rate world requires a change in thinking toward generating retirement income, especially with today’s longer lifespans. Forget the good old days, they’re done. You can no longer live off the interest, but you can still make your money last with comprehensive planning, disciplined investing and an intelligent approach to portfolio withdrawals.