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| Use a globally diversified portfolio that generates enough income to cover the current spending needs without having to sell assets. |
PART 7 of 7 Series:
THE ROAD OF RETIREMENT
The Process of Managing Retirement Income
Retiring baby-boomers, who can expect to spend 30 to 40 years in retirement, will likely need a framework for converting their savings into a sustainable monthly income stream. Investors who are on the road of retirement all share some common fears including spending too much, principal loss from market volatility, loss of purchasing power due to inflation, and the biggest fear of all, running out of money.
As we have all experienced over the past few years, retirement plans designed to fund annual spending solely through the sale of the assets are exposed to the vagaries of the market.
We will outline how to convert the retirement savings to a monthly spending amount, using an approach that balances the need for current income and future growth.
The objective of this conversion process is to utilize the strategies outlined in this series to build the framework that may help a retiree sustain a lengthy retirement time frame. This process will use a globally diversified portfolio with a cash flow reserve ladder structure that strives to generate an attractive level of current income with the possibility for growth.
Cash Flow Reserve Ladder
This ladder provides three rungs aligning the most liquid investments to fund near-term spending needs, while the more volatile, growth-oriented investments are held inside a diversified portfolio with a five-year investment horizon.
Using a cash flow ladder, the retiree writes a check each month from the money market fund within the cash flow reserve and deposits it into their checking account. Providing a specified amount each month is a key attribute of the structure while also giving the retiree some separation from the larger pool of assets in the investment portfolio. This separation can help reduce the desire to overspend.
Within the various levels of investments from the cash flow reserve and investment portfolios, the interest and dividend income generated will not initially be re-invested. Instead this income will be deposited into the money market fund to continually replenish the cash flow reserve. However, if the income stream grows adequately enough to cover the spending amount and more, the excess is reinvested in the investment portfolio. The concept is to use a globally diversified portfolio that generates enough income to cover the current spending needs without having to sell assets. However, whatever portion of the spending is not covered by the current income will come from selling assets opportunistically into the market to refill the cash flow reserve back to the two-year spending level.
Using a Globally Diversified Asset Allocation
Given the opportunities globally to invest in companies that have the ability and willingness to pay a high and growing dividend, the equity portion of the retirement portfolio will be allocated to these types of income investments. The balance of the portfolio will be allocated into municipal bond investments to help preserve capital, offer some diversification and provide a tax-efficient interest income stream.
- The cash flow reserve portion of the portfolio represents approximately two years' worth of spending and is equally divided between a short-term municipal bond fund and a municipal money market account. A short-term municipal bond fund is used since it may provide a higher income stream with a historically limited level of volatility. The cash flow reserve receives income generated from the various investments and is also the source from which the monthly spending check is written by the retiree for deposit into their checking account.
- Within the investment portfolio there is an additional 25% or approximately four to five years of spending allocated to intermediate-term (10-year) municipal bonds, which can be liquidated if there is a protracted decline in the equity markets. These municipal bond investments can help provide a more tax-efficient income stream and some good diversification benefits to the growing dividend stock strategy. Although the income from municipal bond investments is exempt from regular federal and state income tax they may be subject to the alternative minimum tax (AMT).
In terms of income expectations from the municipal bond investments, while the current level of income may be relatively attractive, they are not geared to grow. A common flaw of retirement portfolios is an over-allocation to fixed income investments, leaving the portfolio highly susceptible to the loss of purchasing power.
Using a global approach to investing in companies that provide growing dividends allows an opportunity to improve portfolio diversification by industry, sector, and country.
Using the Cash Flow Reserve Ladder, with its focus on maintaining two years of liquidity in the reserve, together with an allocation to municipal bonds, allows a portfolio to benefit from the growing dividend income stream while also alleviating the need to sell these more volatile equity investments at inopportune times.
Best Practices
A structured process for converting hard-earned retirement savings into a monthly spending amount should be attractive to the majority of baby-boomers looking to retain control of their assets in retirement. Three to five years before your planned retirement date, begin investing in a well managed globally diversified portfolio of high and growing dividend stocks.
One of the best ways to increase the potential for a higher dividend income stream at the time of retirement is to get a head start.
Reinvest the growing dividend income that's generated before the retirement begins, thereby buying more shares and increasing the level of dividend income available when retirement distributions finally do begin. And remember to revisit the retirement plan annually with your financial advisor.
Let us get you started!
Online at our website: www.LamonAndStern.com
Call us at 770-951-8411
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Disclosures:
Following these strategies does not assure or guarantee sustainability of a retirement portfolio or better performance, nor do they protect against investment losses.
Investments in stocks and bonds are not FDIC insured, nor are they deposits of or guaranteed by a bank or any other entity.
Investments in a money market are not FDIC insured, nor are they deposits of or guaranteed by a bank or any other entity. Although a money market fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in a money market fund.
Investing outside the United States, especially in emerging markets, entails special risks, such as currency fluctuations, illiquidity, and volatility.
Diversification does not assure or guarantee better performance and cannot eliminate the risk of investment losses.
