Monday, 21 March 2016

A simple, effective way to generate the income needed in retirement

One of the biggest challenges most people face in retirement is generating the regular income they need and maintaining it for the rest of their lives.

You may have substantial assets, but they're not limitless, so you must be careful how you manage them. To meet the dual goals of generating needed income and sustaining it this is what you do.
First, determine the amount of annual income you need currently—say, €50,000—and then determine the best place(s) to get it. It won't all come from your retirement account because you likely have other income sources: State benefits, perhaps a pension, an inheritance, earnings from a part-time job and funds from other savings or investments.

All of those could reduce dramatically the amount you need to generate annually—perhaps to as little as €25,000 or €30,000.

To determine the rate of return you need to earn on your investments in retirement, factor together all of these realities and your personal preferences: Do you want to leave something for your heirs, preserve capital or spend it down? Then it's time to design a portfolio to meet that target.
Once you have the right portfolio, what is the best way to invest it? Well, if diversification is important to use throughout your working career, as I have long espoused, then it's doubly important once you're in retirement.

A diversified portfolio, of course, contains some assets that don't generate income or dividends, along with others that produce those unpredictably, making it difficult to carry on your lifestyle.
That's solved by a systematic withdrawal plan. It's simple and effective and it works like this: You decline to pocket the interest and dividends from your investments, instead reinvesting them back into the portfolio. To compensate for giving up that income, you arrange to receive a similar monthly amount from your account.

There's a big difference between that and drawing the income that a portfolio produces, as many retirees opt to do. Here's an illustration: Say you had invested €100,000 in a one-year fixed interest bank deposit and received the annual interest each year from 2005 through 2015. The interest would have fluctuated wildly—from €700 to €4,210—and produced €19,520 in income over the 10 years. The original €100,000 remained unchanged.

However, if you instead created a diversified portfolio the account's value would have grown to €198,126. You could then start producing twice as much income and easily offset inflation.
You could have systematically withdrawn twice as much in annual income as the bank deposit, and your account value would still have been 74 percent higher than the banks value. Even if you took triple the income of the bank deposit, your account would still have ended nearly 40 percent higher than the bank deposit.

Simply matching, doubling or tripling the banks income, however, would have left you with inconsistent monthly and yearly amounts. To solve that problem, you could have arranged for a consistent monthly withdrawal, just as you get from Social Security or a pension.
If you took a 5 percent income stream from the starting capital you would have received €50,000 income and your ending value would still have been €158,680—or 58% more than what you started with.

Of course, my illustration is hypothetical over a specific time period. Different periods and asset mixes would produce different results and, as always, past performance does not guarantee future results but you get the idea. I recommend this as the best approach for generating the regular income you want/need to live on in retirement and sustaining it for your lifetime.

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