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Investing for Income in Retirement

If you’re nearing retirement, what steps can you take to build a portfolio to generate liquidity, income, and potential growth to support you? And how will you continue investing after retirement?

The answer doesn’t have to involve a lot of fancy footwork, says Rob Williams, vice president of financial planning and retirement income at the Schwab Center for Financial Research. A combination of familiar strategies and investments can help maximize your portfolio’s income potential.

“You can use building blocks,” Rob says. “Some to help secure your income, some to help provide growth. In today’s market, building a diversified portfolio, in our view, is the best approach.”

Step 1: Build in downside protection

Given the volatility in the markets, a smart income strategy in retirement planning should include cash for liquidity—and downside protection, Rob says. When investing after retirement, you can have cash available when you need it, reduce potential losses and still keep part of your portfolio focused on longer-term growth.  Here's one approach you can take:

  • Set aside one year's worth of expenses, after accounting for other non-portfolio income sources, in a liquid cash account. This reserve is the money you need to supplement your regular income sources, such as Social Security or a pension.
  • Keep an additional two to four years’ worth of expenses within your portfolio in short-term bonds or bond funds in case of a market downturn. With this cushion, you’ll be less likely to have to sell more volatile investments at a loss. (On average, over the last 50 years, it took the S&P 500 about three years and eight months to recover from a downturn).

Having these reserves in place may also help protect you from sequence-of-returns risk, a sharp drop in the market just as you retire. If the market dips early in your retirement when you’re first taking withdrawals, it can be more difficult for your portfolio to recover from those losses, increasing the chance that you will run out of money. Having sufficient short-term reserves can help save you from having to deplete your core portfolio.

Another way to add downside protection is to purchase an annuity. An annuity can provide a steady income stream. But the terms, quality and cost of annuities vary widely. Annuity guarantees depend on the financial strength and claims-paying ability of the issuing insurer. It’s best to consult with a financial professional to select an annuity that will suit your specific needs.

Step 2: Focus on income and potential for growth

With some protection in place, you can now consider investing the remainder of your portfolio in assets that have greater potential for investment income and growth, depending on your time horizon and risk tolerance.

Dividend-paying stocks are one option for the equity portion of a portfolio in retirement. While these stocks are not a substitute for bonds,  you may want to integrate more dividend payers into your stock allocation if you’re aiming for a portfolio for income.

When choosing stocks for income, look beyond the current dividend rate, Rob advises. It pays to examine a company’s cash flow to see if it can continue to cover its dividend. Other factors to consider before buying an income stock include whether the company is selling any assets and how consistently it has offered its current yield over the past five years.

Also be sure to account for broader economic issues. For example, energy stocks could trim their historically impressive dividends because of depressed oil prices. By contrast, financial services and many established tech companies have been increasing their dividends in recent years.

Investors seeking yield may be tempted to consider real estate investment trusts (REITs) for a portion of their stock allocation. These securities invest in income-producing properties and are required by law to pay out at least 90% of their taxable income to shareholders in the form of dividends.1

Be aware that many REITs are sensitive to interest rates, with the asset class as a whole tending to underperform in rising-rate environments. That said, they can be helpful as part of a dividend-oriented allocation, says Rob. And as always, keep diversification in mind as you build your portfolio.

Step 3: Consider a “total return” approach

Think of the methods above as a way of structuring your portfolio for retirement. When it comes to distribution, a “total return” retirement income strategy may help you meet your income needs.

Given today’s low-rate environment, it may not be practical—or optimal—for most investors to depend solely on investment income to support them, Rob notes. Investors also have the option to sell a portion of their assets, especially investments whose value has grown. 

This approach doesn’t necessarily mean “tapping principal” or “drawing down your portfolio,” says Rob, which may sound taboo to some investors. It’s helpful to broaden your definition of income, Rob says, and use multiple sources of return from your portfolio.

Often, the routine process of rebalancing your investments presents the ideal time to sell assets and harvest gains, if investment income isn't enough. Rebalancing involves selling the securities (stocks, bonds, etc.) that have grown beyond their percentages in your asset allocation plan due to the relative gains and losses across your portfolio. By selling the outsize positions, you can reallocate to your targets, help manage your risk exposure and generate the cash you need in addition to investment income.

You may want to enlist the help of an investment professional to decide which to buy and sell to bring your portfolio back in line with your plan and generate the income you need.

If you structure your portfolio to include short-term reserves and income-producing equities—as well as considering total returns in your distribution strategy—we believe it’s possible to maximize your income by increasing your portfolio’s income-generation potential without being held captive to low interest rates today.

1 REIT dividends typically aren't treated as qualified dividends and will generally be taxed at higher ordinary income tax rates.

What you can do next

Important Disclosures:

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Supporting documentation for any claims or statistical information is available upon request.

All annuity guarantees are subject to the financial health and claims-paying ability of the issuing insurance company. Neither Schwab nor its affiliates provides insurance guarantees. An annuity’s payment guarantees are provided by and only as strong as the financial position and claims-paying ability of the issuing insurance company. Schwab does not provide any insurance or other guarantee. Consult the insurance company’s ratings for its financial strength, and read the annuity contract and/or prospectus before investing. Insurance company ratings do not apply to the performance of variable subaccounts. Ratings are subject to change. There is no guarantee current ratings will be maintained.

Charles Schwab & Co., Inc., a licensed insurance agency, distributes certain life insurance and annuity contracts that are issued by non-affiliated insurance companies. Not all products are available in all states.

Schwab Private Client™ ("SPC") is a non-discretionary investment advisory service sponsored by Charles Schwab & Co., Inc. ("Schwab"). Schwab Private Client Investment Advisory, Inc. ("SPCIA") is a Registered Investment Advisor and provides portfolio management for the SPC service. Schwab and SPCIA are affiliates and are subsidiaries of The Charles Schwab Corporation.

Risks of the REITs are similar to those associated with direct ownership of real estate, such as changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and credit worthiness of the issuer.

Rebalancing and diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The information presented does not consider your particular investment objectives or financial situation (including taxes), and does not make personalized recommendations. 

Investing involves risk including loss of principal.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

Past performance is no guarantee of future results, and the opinions presented cannot be viewed as an indicator of future performance.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.


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