The money Georgina and I have been saving all these years is not going to be laid to waste.
Not that we will follow the latest fad and “die broke.” I expect our daughter will inherit a fair amount, including our mortgage-free home and a few of our investments.
But Georgina and I plan to “spend down” most of our nest egg in retirement. I expect our strategy will provide us with a growing stream of income rather than just fixed-income payments, so we can keep up with inflation.
And we will not be afraid to “invade principal” to pay for our needs, or to enjoy ourselves, provided we have enough.
How to make our savings last has been on my mind after I hit 50 about 2 1/2 years ago. It’s a subject that also interests–and worries–many of you, judging from your letters.
But it’s not a subject that gets the attention it deserves in the financial press. There is no shortage of articles telling you where to invest your money, but not enough showing you how to spend it.
That’s too bad because how we spend down our money can affect the quality of our financial life as much or more than how we invest it.
And, long before we retire, we need to consider investments for their potential to provide us with the most retirement income.
Unfortunately, this is a complicated subject that can’t be covered adequately in one column. Today I will give you a broad outline of our “spending plan,” and the principles behind them. In future columns, I will go into more detail about each part of our plan.
Let’s start out by defining our basic goal: To receive the highest possible after-tax income from our investments each year that we can reasonably expect to last us throughout our lifetimes.
Right here we need to define income. For too many people, needlessly worried about not touching their principal, income means only interest or dividend payments. To us income will mean cash flow, or money coming in.
There are basically five ways we expect to get our income after we retire:
– Simply by taking the money out of existing accounts, preferably without owing any taxes. A simple example would be withdrawing excess money from the bank.
– The “traditional” way, by collecting the interest or dividends from our investments.
– The “cash flow” way, which includes the sale of stock and mutual fund shares.
Because stocks historically have provided greater returns than bonds or other fixed-income investments, it makes no sense to limit our “income” potential by shying away from stocks in retirement.
Of course, stocks can go down as well as up. That’s why we plan to use a conservative growth and income mutual fund we already own for most of our “cash flow” strategy.
Periodically we will sell shares of the fund to provide us with “income” in retirement. We will pick which shares to sell–the ones that will give us the best combination of the income we need, and little or no taxes.
– The “growing dividend” strategy.
We own the stocks of half-a-dozen companies with a history of raising their dividends each year. We bought these stocks because we think they are solid long-term investments, and we expect the share price to rise over time.
But in the back of our minds we were also thinking of a growing stream of retirement income down the road.
Today, with dividend yields at a record low, you may not think of stock dividends as a source of income. But suppose you buy a company yielding 2 percent today, and the dividend is raised 10 percent a year.
In 14 years, based on the price you paid for the shares, your dividend would amount to an 8 percent yield.
“To me this is a great strategy for retirement planning,” said Steve Norwitz, a vice president of the T. Rowe Price family of mutual funds, who has done studies on the subject.
For this strategy to work, of course, you need to get started long before you need the income.
“It’s particularly enticing for people who are 10 to 20 years away from retirement,” said Bill Stromberg, who manages a T. Rowe Price mutual fund that invests in companies with a history of raising their dividends.
His Dividend Growth Fund, for example, paid investors a dividend of 2.9 percent its first year in 1993. The yield, based on the original investment, went up to 3.6 percent in 1994, 4 percent in 1995, 4.3 percent in 1996 and 5.5 percent last year.
– The excess dividend strategy.
With part of our money, we plan to invest in a high-yield bond fund but not spend all the dividends. We would spend only so much, say up to a 7 percent yield, and reinvest any dividends over and above that amount.
Because yields tend to go up as share prices go down, we would be using any additional excess dividends to buy more shares at lower prices. That would give us a shot at growing our principal over time.
All of these strategies have risks and drawbacks, which is why we plan to use a combination of all, not just one.
The one you may think is the “safest,” living off the interest off a bank CD, runs the greatest risk of all: not giving you the income you need.
