Avoid Trojan Horses In Planning For Retirement

January 02, 2009

As retirement approaches, tweaking your focus from growth to income is a key. Here are some suggestions on how to strike a proper balance.


If you're one of the millions of baby boomers soon to exit the full-time workforce, a stark reality of investing on a fixed income is about to take center stage. 

It's likely you still haven't accumulated a large enough retirement nest egg to be absolutely certain of not running out of money during a hopefully long and fruitful retirement.

But take heart. It's a sobering truth facing almost all of us at some point—whether we're approaching retirement or already at that point in our investing lives. 

You've probably heard the warnings before. And they keep coming. Labor exports are now estimating that 25% of all retiring Americans will be dependent on working part-time jobs after they begin to draw Social Security benefits. Another stark reality facing retirees in coming years is that with increasing medical breakthroughs in cancer and heart disease research, many retirees may live years beyond their current life expectancy.

The traditional solutions to solving retirement shortfalls are not reassuring. The usual mantra on retirement Web sites is to save more, cut expenses, delay retirement or continue working part time. 

A much easier retirement strategy is to reduce your growth investing and invest primarily in investments that always pay monthly or quarterly distributions. You can accomplish this quite simply by diversifying most of your retirement dollars into high-income-paying stock, bond and "alternative investment" exchange-traded funds.

The Trojan Horse Of Retirement

Traditional retirement planning often advocates investing in growth stocks or mutual funds and systematically withdrawing monthly checks of 6-7% per year. A more conservative financial planner might suggest withdrawing less. But what's the risk in withdrawing only 6-7% when the market historically grows 9-10% annually? Aren't you spending less than you're earning?"

Wrong! No you are not. And that's the great Trojan Horse of retirement investing. What you expect is not what you get. Inside that wonderful old-world strategy in which growth stocks historically have been dependable generators of 10% annual earnings is a startling surprise. While you may be withdrawing just 6-7%, your principal is being mercilessly invaded every time the market dips.

How so? If your fund doesn't pay distributions, you must sell principal shares to meet your monthly income requirements. In a bear market, this steady sale of shares greatly accelerates—the greater the market decline, the more shares you need to liquidate. Admittedly, the lower your withdrawal rate, the longer your principal will last. But sooner or later the result will be the same—your principal will be gone.   

Consider a study by Ibbotson researchers in 2005 looking at withdrawal rates from a 50/50 balanced portfolio of stocks and bonds from 1972-1995. It's sobering. Even modest withdrawal rates eventually exhaust your principal. Here's a look: 


Withdrawal Rate

How Long Until Principal Exhausted


22 Years


15 Years


12 Years


10 Years


9 Years


With today's dividends and interest rates yielding 5-10% and even higher, most retired investors should never need to withdraw principal to live on. It is crucial, in fact, that you only withdraw the income you earn on your principal—the dividends and interest.

True income investors should never need to make withdrawals from their principal. Never.


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