How to Generate Income in Retirement
By Scott Wohlers, Vice President
The adage before the financial crisis of 2008, was to save $1,000,000 for retirement, invest that in treasuries or bonds that paid close to six percent interest and live off the interest. For example, if you had saved $1,000,000 and were able to get a yield of six percent, it would provide an annual income of $60,000 while preserving the principal. However, that has all changed as we saw interest rates go to zero after the financial crisis. This has thrown a curve ball to those who were retired or have been contemplating retirement. People now must save more as we are living longer and options that are deemed “safe” don’t provide enough yield to provide adequate income. Because the yields are so low, retirees have been searching for other investment options. Bank offered certificates of deposit (CD’s) that have been paying low yields for years, just recently crossing the two percent threshold. The US 10-year Treasury hit three percent for the first-time last year, and has quickly retreated to two percent, still well short of the yield retirees need. Another deterrent with CD’s offered at your local bank is that they often come with an early withdrawal penalty. This has left retirees searching for alternatives that provide the yields they need to preserve their nest egg as well as creating the income they need.
Some have looked to insurance companies offering fixed annuity contracts that pay a little higher rate than CDs, still their return is well short of what is required to live on. Also, these contracts are typically either five to seven-year contracts that often have huge surrender charges if you try to take your money out early. They also have complex, hard to understand contracts that you sign just to give them your money in exchange for a return. Other alternatives are income annuities that provide an immediate income stream. They typically require that you turn over a lump sum to the insurance company and they pay you a monthly income for your life. They may not return any of that principal to your heirs and may not continue to pay any spousal benefits. Annuities are also very costly to cancel, and their contracts can be very difficult to understand. These options can come at a very large cost to investors based upon the returns they provide.
Corporate AAA rated bonds, deemed riskier than Treasuries and CDs, have also been a vehicle used in the past to provide investors with a good return. The AAA rating provides the investor with confidence in the balance sheet of the company they are buying the bonds from. However, the corporate bond rates for ten-year bonds have failed to reach above a three percent return. They provide income either quarterly, semi-annually, or annually to investors. This can cause problems with budgeting and may cause issues with liquidity as these are ten-year investments. If interest rates rise over the next ten years, you may face challenges re-selling the bond to liquidate your position.
With all these low yield investments that seem to have different levels of risk and principal reduction in fees, what are retirees to do? One strategy that has stood out from the crowd is investing in high dividend paying stocks. Companies offer dividends to attract investors into buying shares of their company. When a dividend is announced, corporations declare a fixed dollar amount per share they will offer as a dividend. The dividend yield is then calculated by dividing the fixed dividend amount by the share price. For example, if ABC Corp pays a $4.50 dividend per share and the stock price is $100, the dividend yield is 4.5 percent. If the stock goes up to $110 or drops to $90, you still receive $4.50 per individual stock share that you own. One thing to keep in mind when putting together this strategy is to not just search for the highest yielding stocks. They can often pay a high yield; however, they may have no growth or appreciation and may move downward in share price more than the market itself.
At Riverplace Capital, we worked hard to research and identify stocks that are paying a good dividend and have growth or appreciation potential. We do our best to target stocks where the average yield will be around 4.5 percent, giving a much greater yield than you can get with traditional CDs, Treasuries, Annuities, or Bonds, while being very liquid–meaning when you sell shares you don’t have early withdrawal penalties.
For example, referring to our initial example of a $1,000,000 portfolio, if you invested in a dividend portfolio that yielded 4.5%, that would provide an annual income of $45,000 regardless of appreciation or depreciation of the stocks itself. This is a significant benefit for helping retirees not burn through the principal that is providing a stable income. This gives you the opportunity to take advantage of appreciation of the stocks in your portfolio while also getting the returns from the dividends. Historically, the average return in the stock market is around 8 percent, while past performance is no indication of future returns, the upside appreciation opportunity is much larger than traditional fixed vehicles like CDs, Corporate AAA bonds and annuities. Just like with any investment, there is risk involved, dividends are not guaranteed. That is why we believe it is important to work with a team that is actively monitoring and updating your dividend portfolio to help you navigate through your retirement. If you would like to learn more, contact us at (904)346-3460 or [email protected]