Ok...so to rehash what we have so far to get most people on track for a nice retirement: for your first job, assuming the company has a decent 401(k) just elect to put at least 10% away out of each paycheck and pick the Fund corresponding to the retirement date or life cycle or target date Fund. Forget about it, go to work and when it reaches $60,000 or so say switch to a well defined asset allocation using low cost index Funds.
How to do this can be presented by Human Resources on the first day of employment by using a short online video. Why can't Fund providers do this? Well, they can but they won't because they get far greater fees by getting Plan participants to use higher cost actively traded Funds that they switch around frequently.
The beauty of going target date Fund and then low cost Funds is that it gets over some formidable hurdles. First, many would be participants back off because there are so many choices. Economic theory has found that too many choices is actually not a good thing in many instances. Secondly, many would be participants just don't understand the process and that they are responsible for building their own nest egg. They think it takes time and expertise to do this. In fact, it runs itself once it is set up.
Now we come to the third and final phase. This is when you have reached the point where you need to generate an income off your nest egg. Note that at this point your goal has changed significantly from growing your nest egg to generating an income off of your nest egg.
There are some choices here. Today for example you can get approximately 5.5% off your nest egg by buying a single premium immediate pay annuity. This is an insurance product that pays a monthly income (or at whatever interval you pretty much request) and has the clear advantages of ensuring you never run out of money and not being subject to a possible sharp drop in the market. The big disadvantage is that you lose control of the money both for emergency needs and for leaving assets to heirs.
Another choice is to invest in Treasury Notes. At the present time the 10 year Treasury Note yields 1.6%, about in line with the rate of inflation. A big disadvantage in addition to the low yield is that the interest payment stays constant over the life of the Note. This means that the interest payment you receive over the next 10 years would stay the same. Assuming inflation rises this means you would be losing ground.
The third alternative is to create, in effect, your own annuity by using dividend stocks. For the retiree willing to spend some time at it there are numerous solid stocks that offer yields of 3% and higher. Furthermore, they have a history of increasing their yields. To get an idea of the stocks in this category just Google "dividend stocks" and you'll come up with all kinds of listings. Finance magazines such as Barron's, Kiplingers. Money etc. constantly provide lists of attractive dividend payers as well.
But what about the possibility of the market dropping? After all, at this point we are in retirement and as commenters like to say "retirees don't have much time for the market to recover after a downturn". This actually isn't too great an issue in my view if you frame the process appropriately.
Think about the first two alternatives: an annuity and a Treasury Note. In each instance we did the investment and then whatever happened to the market didn't matter. Think also about your Social Security. Does a market downturn have any impact on Social Security?
The point here is that once you have invested the main concern is with your income stream not with the market value of the portfolio. Odds are that with some basic principles your income stream should increase as your stocks increase their dividends. If over time your portfolio rises in value it's basically gravy. If it drops it is no big deal, again as long as your income stream holds up.
What are the basic principles? First, limit the size of specific company holdings to 5% of total assets. This limits the impact of a negative event. Secondly, be careful about industry diversification. For example, choose Verizon or AT&T but not both. They are in the same industry. Choose one or two energy companies, utility companies, banks etc. If you extend to riskier companies invest 2.5% of total assets. You'll find business development companies that offer, for example, double digit yields. Always remember that extra yield means extra risk.
A negative for this approach is that it takes time. The first two approaches ran themselves. Not the dividend portfolio. But some retirees find that creating a dividend portfolio and managing it is a great "hobby" in retirement. As you get into it you find numerous opportunities, on an ongoing basis, to increase yield and improve the portfolio. The bottom line is that it can pay off nicely for the retiree willing to put in the effort.
Thoughts and observations for those investing on their own or contemplating doing it themselves.
If you are seeking investment help, look at the video here on my services. If you are seeking a different approach to managing your assets, you have landed at the right spot. I am a fee-only advisor registered in the State of Maryland, charge less than half the going rate for investment management, and seek to teach individuals how to manage their own assets using low-cost indexed exchange traded funds. Please call or email me if interested in further details. My website is at http://www.rwinvestmentstrategies.com. If you are new to investing, take a look at the "DIY Investor Newbie" posts here by typing "newbie" in the search box above to the left. These take you through the basics of what you need to know in getting started on doing your own investing.
Monday, September 5, 2016
A Proposal - Step 4
Posted by Robert Wasilewski at 9:17 AM
Labels: retirement date funds, retirement income
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