Investing in Equities for Retirement Income

George and Sherry never had to ask, “what’s next?” They had always planned everything. But life threw a wrench into their plans when George was let go during the recent economic downturn. George was ready to retire, at least emotionally. The kids were raised, the bills had always been paid, but they just were not certain that retirement was a prudent decision. Furthermore, they were afraid to start income from the investments and just felt like “we were due for a big stock market crash.”

Thinking about retirement income can be stressful. The investment options can seem both overwhelming and limited. Overwhelming because there is a huge array and a seemingly endless number of investment solicitations, advertisements and opportunities. And, on the other hand, our investment options seem limited because of today’s low interest rates; very few investments provide the income that many retirees need.

Investing in common stocks, equities, is one way to provide income and growth, but most importantly, growth on the income. Many investors shy away from equities because of three big problems:

• Volatility
• Inflation
• Sequence of returns

Volatility is not the same as risk

The volatility of stocks can be scary. The headlines often tout the most recent decline and warn of future declines. As we know, bad news sells. The average annual decline of US stocks is greater than 10%, and every four or five years the decline is greater than 20%. Still, the average rates of return for equities are higher than 10%—inclusive of the declines. And, over the past decade, the US stock market is averaging greater than a 14% annualized rate of return.

To address the volatility concern, consider changing your perspective. After a decline, the odds of future higher average annual rates of return increases. The dips are likely short-term, whereas the gain is historically positive over long periods of time. Volatility is the reason equity markets provide greater rates of return compared to other investments. While others are selling, the wise investor is holding—and if possible, buying more—equities because the odds of future gains are in their favor. 

Let’s discuss two risks the long-term investor races:  they may need to pull income from the equities during a decline. More on a simple, straight-forward solution for that problem in a minute. The bigger problem for a long retirement is inflation. 

Inflation is a real long-term risk

There is a greater risk to investing than the risk of a short-term decline, and that is the risk of inflation. As we age, almost everything we buy gets more expensive. Inflation eats away at purchasing power. To overcome this risk, the investment needs to provide an income that grows faster than the rate of inflation. Over long periods of time, equities historically provide both income and growth. Perhaps most importantly, dividend paying equities provide growth on the income.  

See also: Dividend-paying Stocks Offer Retirement Investors Income and Potential Growth

Because of the volatility, an investor might want to choose an investment that pays a fixed income, like a bond or bond fund. The problems are twofold: an immediate problem and a long-term problem. Right away, a fixed income investment, in today’s low interest rate world, may pay an income too low for most investors. And over the long haul, inflation is going to make the income even lower. Hence, equities likely provide the long-term retiree a better chance for real-life success. Odds favor an investor who can focus on the total return of the investment—the long-term growth plus dividends provided by equities.

Sequence of returns—the next big stock market crash!

The most common, largest risk that an equity investor faces today is the risk that we are right on the precipice of another huge stock market crash. Early retirees fear turning off the income-from-work faucet and depending entirely upon income from investments because it “just seems like we are due for a stock market crash.”

Indeed, it is easy to recall stories of the “lost decade” after the dot-com crash and similar stories in the years after the 2008 financial crisis. However, much less published, are the returns equities provided in the years since that time. What’s more, the long-term growth in equities inclusive of these “terrible stock market crashes” has exceeded other asset classes. 

One practical way that an early retiree can overcome these risks is through the prudent use of cash, or the equivalent. Set aside two to four years of expenses, depending upon your ability and your level of concern. Leave that money alone and do not worry about its rate of return. Especially in today’s low interest rate world, the return will be negligible. Instead, this money will enable the vast majority of your nest egg to earn the historically superior, long-term rates of return provided by equities. 

When you need to make a withdrawal, pull from the cash. Annually, replenish the cash bucket with the growth from equities. In bad years, skip the replenishing and pull again from the cash bucket. This way, you keep the equities working in your favor. The more years of cash you have in the cash bucket, the more likely you are to be selling stocks after gains, and not have to worry about pulling money out during the temporary declines.

In conclusion

George and Sherry were nervous about turning on the income from their investments. We listened carefully and followed the prudent process of a Certified Financial Planning Professional™. We:

• Completed a discovery meeting
• Created a realistic financial plan, including stress testing a variety of situations, just to be sure
• Consolidated the investment accounts
• Created a retirement income plan, including cash “buckets”
• Perform ongoing investment and financial planning

George and Sherry view retirement as a wonderful party. “Sometimes, God laughs at our best laid plans. But I think we have the last laugh. We’ve never had so much fun together!” said George. By investing in equities for growth and income, George and Sherry are secure, relaxed and enjoying their newfound freedom.

Investment advisory services offered through A & I Financial Services LLC, registered investment advisor. Securities may be provided through Geneos Wealth Management Inc., member FINRA, SIPC. George and Sherry are a hypothetical couple based on a real-life family.