Retiring without the worry of running out of money is a major goal for many of us. But what is the best way to ensure that you never run out of money in retirement?
It used to be that many retirees lived off of a pension, interest income, Social Security, or all three. This made for a stress-free retirement in terms of money because income was covering expenses, and they didn't need to dip into their investment principal.
Today we see fewer pensions, very low interest rates, and fears that Social Security may not pay out promised benefits. That is why I recommend looking at covering retirement expenses with dividends.
Interest Payments Will Not Cut It
There is no chance that interest payments from bonds will cover retirement expenses for the vast majority of people out there. Interest rates are just too low. Not long ago, we saw a ten-year Treasury yield above 5%. Today, with yields around 2.5%, you would barely beat inflation.
Another way of looking at this is, with a $1 million portfolio, if inflation is 2.3% per year and your bond yields are only 2.5%, you would only generate $2,000 in real income (after inflation) per year! Who can cover retirement expenses with that?
Dividends To Replace That Income
Instead of using interest income, I suggest looking to solid dividend payers that have a long history of increasing their dividends over time. My research has found many great candidates and I list a few below:
Annual Dividend Growth (5-Yr)
Consecutive Div Increase (Years)
National Retail Properties
*Local currency. Data as of January 31, 2017.
Generating a yield of 4.6% is certainly better than a 2.5% bond yield. If you add in the 6% dividend growth, that would give an annual return of about 7.5%. This also does not take into account any price appreciation over time.
Of course, dividend-paying stocks are likely to have more volatility than Treasury bonds over time. What most people don't realize, however, is that the volatility of total returns goes down substantially as dividend payments keep increasing. This is because the price portion of the total return has less and less of an impact as time goes on and the more stable dividend payments have more of an impact.
An Example: Jake and Mary
Instead of just talking about this idea, let's put some real numbers to work using the WealthTrace Retirement Planner.
We have a married couple, Jake and Mary, who are 53 years old. Their investment portfolio totals $575,000, all of which is in IRAs. They plan on retiring in ten years and they project their spending at $60,000 per year. Their current portfolio is 50% in stocks and 50% in Treasury bonds. I have assumed the rate of return on stocks will be 7% and their bonds will return 2.5%.
I ran their retirement plan using our Monte Carlo simulator. I found their probability of never running out of money to be 56%. The Monte Carlo analysis runs 1,000 scenarios on their plan, shifting the rates of return in each scenario, and tells us the number of times they did not run out of money over the life of the plan, assuming they both live to the age of 90.
A 56% chance of not running out of money is a serious problem. So what is the solution? As I mentioned before, we should look into moving them into strong dividend payers. Instead of a 50/50 split between stocks and bonds, I instead placed 70% of their money into our dividend portfolio and left 30% in Treasuries. I ran the analysis again and found the following result in Monte Carlo simulations:
This is clearly much better. It shows the power and stability of dividends over time that come from companies that have a long history of dividend payouts and dividend growth.
It is not nearly as easy as it used to be to generate sufficient income in retirement. We can find great companies that pay a growing dividend over time and that is the key for many so that they can cover their retirement expenses.
Regardless of where you plan to retire, the number one factor in ensuring that you can retire on your terms is your 401(k). Make sure that your 401(k) is maximizing its potential with this free analysis that checks your fees, fund mix, and other factors to help you hit your retirement goals.
Originally Posted at: https://www.moneytips.com/living-off-of-dividends-in-retirement