After speaking with many retirees about their finances, it has become abundantly clear that one thing many miss is the regular income provided from a job and they want to replicate that feeling of a regular paycheck from their investments.
Replacing income in retirement
I get it. I do. The security of a paycheck is what has stopped me from leaving my last job, even though I would have been fine without it for some time now. But to go from spending 40 years earning regular job income to without job income for 30 years or longer is a massive transition.
As nice as that feeling of income can be, trying to replicate that feeling with your assets can potentially lead to inferior results.
A few common assets that people are attracted to for income include:
Rental properties
Lifetime income annuities
High dividend paying stocks
Corporate bonds
There are of course other investments that provide income, such as government bonds, term deposits and savings accounts, but they offer lower potential interest rates than the assets listed above. And to have enough income to sustain your lifestyle, you are likely going to need a very large portfolio value.
The problems with chasing income in retirement
1/. You need a lot of money
To not deplete your savings and produce an income, you will typically need a lot more saved than someone who is more prepared to dip into their capital occasionally if and when required. This means having to work much longer than you want or need to.
An income focused investor can’t afford to deplete their capital, or they will lose some of their income.
2/. Yield can vary
As we saw for much of the 2010’s, interest rates went down, down and down some more. This is bad news for many seeking fixed income. Invested too conservatively and many retirees would be dipping into their capital and further reducing their income.
3/. Less diversified and more risk
Buying a rental property, chasing high dividend paying stocks or looking for high income producing corporate bonds can all mean a lack of diversification relative to someone who is more willing to invest in many assets – A total return approach. Sure, it could work out great for you. But it could also work out poorly. An income approach tends to carry fewer investments than a total return approach and as such, carrier far more risk of concentrated losses.
Because you need to save more money to not deplete your capital, there may also be some instances of an investor who doesn’t want to save that much money and would rather retire now and take a chance. Not having enough saved would require taking on a lot more risk than you would otherwise. This could involve reaching for riskier income producing assets such as B- rated bonds, putting your money in a B- rated bank, high dividend paying stocks with poor growth prospects, or wholesale investment funds.
4/. Income is taxed
Income in NZ is taxed at a much higher rate than capital gains. Sure, chances are many retirees are on a low tax bracket, but income strategies could push someone from a lower bracket to a higher bracket and it also means more of your returns are being taxed.
5/. An income focused investor ignores capital growth
Most retirees have a concern about running out of money. But it is a total return strategy that will often return more money. An income investor predominantly receives income. But a total return investor will get some income, but more in capital gains.
For example, when looking at the historical returns of stocks, the index returns significantly more than high dividend paying stock indexes. Less in income sure, but the substantial gap in capital gains more than makes up for the lower income.
Final thoughts
Of course there are benefits to the income strategy in retirement. Just having that feeling of a regular income makes us feel secure.
It may also mean we are less likely to do something silly. For example, if someone had a total return approach and was invested 50% in stocks and 50% in bonds in 2022 when both had sharp drawdowns, they may have panicked and sold assets at a large loss. Whereas an income focused investor may not have panicked because their money may still have been coming in.
It’s also an extremely simple strategy. No complex ratios or formulas needed.
You can’t discount that.
BUT, I do think there is a big price to pay for that feeling of security. That feeling of warmth you get from a regular paycheck.
There are ways to draw a paycheck from a total return approach. It just requires a bit more planning.
By the way, have I ever told you I can help with retirement planning? 😊
If you need help with your personal retirement planning, then get in touch today.
The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here