How to Avoid Outliving Your Money in Retirement – Part 1
A good friend of mine is going through a difficult time. His mother, now well into her 80s, suffers from dementia and can no longer manage her own affairs so he is taking over control of her financial accounts.
My friend is one of the smartest people I know, but when it comes to investing he realizes that his devil-may-care attitude towards risk could be a problem. That being the case, he asked me for advice on how to set up a steady stream of monthly income for her that she is not likely to outlive.
The good news is his mother is in relatively solid shape financially. She has about $600,000 in savings and requires $3,000 per month to cover her living expenses. That works outs to a 6% annual distribution rate, which is a little on the high side but not excessively so.
Of course, you can’t get a 6% yield from investment-grade bonds now, so that option is off the table. The 30-year Treasury bond offers a current yield of 3.1%, about half what his mother requires. Even if he was willing to consider BBB rated bonds, a 4% yield is about the best he could do.
The Retiree’s Dilemma
So here’s my friend’s dilemma; should he put all of his mother’s cash in “riskless” government bonds knowing he is slowly eroding the principal value of the account (and potentially risking losing it altogether, if she lives longer than expected), or put it in other investments with higher yields that are not guaranteed?
Sooner or later, this is the question most retirees will have to ask themselves since few have the financial means to support their desired standard of living using only treasury bonds. Believe me, I know. I spent most of my financial advisory career as a retirement income specialist, helping thousands of downsized employees grapple with that same question.
As for my friend, he does not realize it yet but he is one of the lucky ones. Producing a 6% yield in this market isn’t easy, but it is possible. In fact, that’s why I created the Maximum Income for Retirees portfolio for my Personal Finance readers three years ago. At that time, the Fed was suppressing interest rates to boost the economy, making it doubly difficult for retirees to generate income.
The portfolio I created, consisting of an even mix of MLPs (master limited partnerships), BDCs (business development companies), and REITs (real estate investment trusts) has produced an average annual yield of about 9% since then. At the same time, its principal value has increased along with the overall stock market.
Hedging Your Bets
Now that the Fed is allowing rates to rise, I don’t expect this portfolio to continue appreciating as much. But that’s okay with me since that isn’t its primary objective to begin with. So long as it produces high current cash flow and its principal value holds steady over time, then it is doing its job.
If you’re worried about inflation gradually eroding the principal value of the type of holdings in this portfolio, you can use a commodity fund as a hedge. In that case, dividing your money evenly over all four asset classes produces a current yield of just under 7% while reducing the impact of inflation on the overall portfolio value.
For example, during the fourth quarter of 2017 my commodity fund appreciated 6.3% while my portfolio of MLPs, BDCs, and REITs declined by an average of 1.2%, for a weighted-average gain of 0.7% (in addition to the 6.9% annual yield). I expect similar performance during the first half of this year while investors adjust to rising interest rates.
I have no doubt that twenty years from now – the average lifespan of most Americans who retire at age 65 – this portfolio will be worth at least as much as it is today and perhaps considerably more. However, I cannot say the same for treasury bonds. If rising inflation is here to stay then there will be no “riskless” income investments, only some that make more sense than others do such as this one.
P.S. Tomorrow, I will examine some of the income investments that investors need to beware of that Wall Street is pushing hard at retiring baby boomers.