It’s All About Income

Cory Davern Financial Planning

Do you think your investment strategy should change as you near retirement or after you retire? I know what you’re thinking…of course the answer is “yes”. You’ve worked a 1/3 or more of your life preparing for this day. You’ve been saving in your 401K, IRAs, and other accounts to build a nest egg you hope will survive the rest of your life. Yet, you have concerns. What if the market crashes in the first few years of our retirement? Will our money last as long as we do? Will there be enough money left for my spouse should I pass away first? How much money can I confidently draw from my savings each year? The list goes on.

 

Most of us probably understand our investment strategy should change as we near or enter retirement, but do we really understand what needs to change once we are about to cross the line from working to retired? Many believe they just need to invest more conservatively; but what does that really mean? Will investing more conservatively help my nest egg last as long as I need it to? If you’re focused only on spending the growth of your portfolio, there’s a good chance your portfolio won’t last through your entire retirement. At least not without a lot of flexibility in how you manage your expenses.

 

Can I ask you to think about something for a moment? What is one significant change you will face immediately when you retire? It may be something you haven’t given much thought. For many of the people I work with, the reality of not receiving a paycheck creates concern, anxiety, and uncertainty. One way to address this is by replacing your paycheck with a different paycheck; possibly from your investments.

 

The first thing I try to help my clients understand is their expenses. We break these expenses down into different categories: Basic Expenses, Discretionary Expenses, and Quality of Life Expenses. Said another way, Basic Expenses are the “Must Pay Expenses or Needs” like food, insurance premiums, utilities, mortgage or other debts, and health insurance. These are the expenses you will have for the rest of your life and must be paid. Discretionary expenses are those variable expenses you can choose to be a part of your budget or you could choose to remove from your budget. These would be associated with things you “want”, but don’t necessarily “need”. Sometimes, it is hard to know the difference, but taking the time to determine whether an item or service is something you want versus something you need can go a long way to helping you successfully manage your expenses in retirement. Finally, we have the Quality of Life expenses. These are things you want to do in retirement; and, in many cases, may be the reason why you are retiring. Life’s “bucket list” falls into this expense category and inadequate planning can leave a retiree short on funds later in life if too much money is spent in the effort to get everything off their bucket list.

 

Here are some strategies you may want to consider as you build your income streams in retirement. For the Basic Expenses, we don’t want income needed to pay these expenses to be variable. We know this money must be there for the rest of our lives. We can’t risk this money not being available because it would mean not having money for food, heating our home, or paying for healthcare expenses. Income sources like Social Security or Pensions can often cover these expenses; at least, for a while. We must remember inflation is ever present eating away at our purchasing power. So, we must determine if there is a “gap” between our retirement income streams and our expenses. Also, is the “gap” present now or will the “gap” appear somewhere down the road. It is important to identify where, when, and how big these “gaps” may be. Typically, strategies offering income guarantees should be considered to assure the income you need will always be there for you…no matter how long you might live.

 

For Discretionary and Quality of Life Expenses, aligning investment strategies which produce income can be an effective way to consistently have the money you need for these expenses. The idea here is to leverage your principal to create income in the form of interest, dividends, or qualified dividends which come to you on a consistent basis like your paycheck when you were working. If designed properly, the income you receive is sufficient to meet your expense demands while helping you prevent drawing down your principal prematurely; or at least delaying it. Also, by not spending down principal, you can prolong the longevity of your portfolio, grow your portfolio through retirement, and create more flexibility in your planning. Because the income created can change, remaining flexible with your Discretionary and Quality of Life Expenses allows you to adjust your spending and avoid spending more than your portfolio is generating.

 

Once you’ve aligned your portfolio to create the income needed to meet your planned expenses, anything left in the portfolio can be dedicated to a growth strategy. I mentioned inflation earlier. You will need to combat inflation as well and this is the part of your portfolio which can help you do just that. Harvesting gains periodically to support the other areas of your portfolio when things are going well and adjusting your variable expenses down when things aren’t going well, can assist in giving retirees the confidence their money won’t run out too soon.

 

When it comes to retirement portfolio management, I sincerely believe it really is all about “income”. If your portfolio is down in value, but you are still getting $3,000 every month, your bills are paid, and you’re able to do the things you want to do, you probably aren’t going to sweat the fact your portfolio is down in value as much. Your confidence is in the fact the income is continuing to come to you each month. But, if you are expecting your portfolio to grow at a specific rate, let’s say 5% per year, what happens to your confidence in your portfolio longevity when your portfolio earns less than 5%? What if it loses, 10%, 15%, 20% or more? If you’re still needing to withdraw money from the portfolio when this happens, you will likely become quite concerned about whether your portfolio will be able to sustain your income needs as long as you need it to.

 

Understanding the various income generating strategies available and aligning those strategies to your various expenses appropriately within your portfolio, will give you much more confidence in the sustainability of your portfolio throughout retirement. Additionally, this added confidence will allow you to enjoy your retirement years much more allowing you to embrace this new chapter of life with more certainty, security, and peace of mind.

 

If you would like to explore how thinking more in terms of income than growth could help your portfolio and retirement income planning, please call us at 303-694-1600. Our advisors would enjoy nothing more than to show you how a Retirement Income plan, designed specifically for you, can help secure the Retirement for which you worked so hard and deserve.