Investing in Equities for Retirement Income
By: Karl Frank
They had always planned everything. But life threw a wrench into their plans when George was let go during the recent economic downturn. George was ready to retire, at least emotionally. The kids were raised, the bills had always been paid, but they just were not certain that retirement was a prudent decision. Furthermore, they were afraid to start income from the investments and just felt like “we were due for a big stock market crash.”
Volatility, Inflation, and Sequence of Returns
Volatility is not the same as risk
Let’s discuss two risks the long-term investor races: they may need to pull income from the equities during a decline. More on a simple, straight-forward solution for that problem in a minute. The bigger problem for a long retirement is inflation.
Inflation is a real long-term risk
There is a greater risk to investing than the risk of a short-term decline, and that is the risk of inflation. As we age, almost everything we buy gets more expensive. Inflation eats away at purchasing power. To overcome this risk, the investment needs to provide an income that grows faster than the rate of inflation. Over long periods of time, equities historically provide both income and growth. Perhaps most importantly, dividend paying equities provide growth on the income.
Because of the volatility, an investor might want to choose an investment that pays a fixed income, like a bond or bond fund. The problems are twofold: an immediate problem and a long-term problem. Right away, a fixed income investment, in today’s low interest rate world, may pay an income too low for most investors. And over the long haul, inflation is going to make the income even lower. Hence, equities likely provide the long-term retiree a better chance for real-life success. Odds favor an investor who can focus on the total return of the investment—the long-term growth plus dividends provided by equities.
Sequence of returns—the next big stock market crash!
The most common, largest risk that an equity investor faces today is the risk that we are right on the precipice of another huge stock market crash. Early retirees fear turning off the income-from-work faucet and depending entirely upon income from investments because it “just seems like we are due for a stock market crash.”
Indeed, it is easy to recall stories of the “lost decade” after the dot-com crash and similar stories in the years after the 2008 financial crisis. However, much less published, are the returns equities provided in the years since that time. What’s more, the long-term growth in equities inclusive of these “terrible stock market crashes” has exceeded other asset classes.
One practical way that an early retiree can overcome these risks is through the prudent use of cash, or the equivalent. Set aside two to four years of expenses, depending upon your ability and your level of concern. Leave that money alone and do not worry about its rate of return. Especially in today’s low interest rate world, the return will be negligible. Instead, this money will enable the vast majority of your nest egg to earn the historically superior, long-term rates of return provided by equities.
When you need to make a withdrawal, pull from the cash. Annually, replenish the cash bucket with the growth from equities. In bad years, skip the replenishing and pull again from the cash bucket. This way, you keep the equities working in your favor. The more years of cash you have in the cash bucket, the more likely you are to be selling stocks after gains, and not have to worry about pulling money out during the temporary declines.
George and Sherry were nervous about turning on the income from their investments. We listened carefully and followed the prudent process of a Certified Financial Planning Professional™. We:
- Completed a discovery meeting
- Created a realistic financial plan, including stress testing a variety of situations, just to be sure
- Consolidated the investment accounts
- Created a retirement income plan, including cash “buckets”
- Perform ongoing investment and financial planning
George and Sherry view retirement as a wonderful party. “Sometimes, God laughs at our best laid plans. But I think we have the last laugh. We’ve never had so much fun together!” said George. By investing in equities for growth and income, George and Sherry are secure, relaxed and enjoying their newfound freedom.
Investment advisory services offered through A & I Financial Services LLC, registered investment advisor. Securities may be provided through Geneos Wealth Management Inc., member FINRA, SIPC. George and Sherry are a hypothetical couple based on a real-life family.