Many retirees have their life savings socked away in mutual funds or ETFs, but is this always the best option for generating income?
This time on Financial Sense’ Lifetime Income Series, Jim Puplava takes a look at different options for retirees to maximize returns, protect their accumulated assets, and best navigate the intricacies of the available options.
The Basics Still Matter
There are around five methods retirees normally use to guarantee income in retirement. One source that used to be more common is the traditional pension. These are increasingly difficult to find, especially in the private sector, unfortunately. Social Security is another source of income for those who qualify.
After those two, people often rely on personal savings and home equity. Many retirees are also choosing to — or are being forced to — work in retirement to supplement their income. Lastly, some rely on inherited wealth to support them in retirement.
Investors who depend on any or all of these resources in retirement may need to plan ahead, though, as the landscape is changing rapidly, and what worked in the past may not work for much longer. In addition to private pensions vanishing, it’s becoming increasingly clear that the public pension system in many places is broken.
“Pensions are underfunded, and there's going to be a tax revolt if they keep raising taxes to fund these pensions,” Puplava said. “You're going to see a shift in the next decade away from these defined benefit pension plans.”
Is Your Nest Egg Safe?
With traditional, predictable forms of income in retirement coming into question more frequently, many retirees will have to rely on working later in life, going back to work, and drawing down on their own savings, Puplava noted.
This brings us back to how savings are invested where, in many cases, people rely on mutual funds.
“The issue is though if you are fortunate enough where you've accumulated a nest egg of over let's say half a million dollars, there are better alternatives,” Puplava said.
From 2008 to 2018, those invested in one popular fund saw their income drop by over 33 percent. And with a bear market in bonds beginning to take over, it may be time to think about diversifying.
“If you invest in mutual funds, bond funds, or ETFs … you (may possibly) see your income decline by almost a third,” Puplava said. “Folks, that is not where you want to be in retirement.”
Secure Strategies in the Current Paradigm
There are several alternatives that offer more control over income and greater predictability in terms of what that income turns out to be, he added. These include individual bonds, dividend-paying stocks, rental income from real estate, and annuities.
Puplava likes floating rate bonds or individual bonds with shorter maturities. If you bought a 5-year bond paying 5 percent interest in 2008, for example, the return is predictable, and at the end of 5 years, you get your principal back. Then, you can buy another bond at a higher interest rate if the returns have gone up. The same goes for floating rate bonds, which adjust with interest rates as they move higher.
“It's more controllable,” Puplava added. “Instead of declining income, you may have fixed income or rising income with floating rate bonds. That’s very important when you are retired.”
Another option is to pick up dividend-paying blue-chip stocks. These are the high-quality stocks that make up the DOW and S&P 500 and have a history of raising their dividends every single year over a 5-year period of time.
Even in a market downturn, investors don’t need to worry too much, because they’re in the blue-chip stock for its dividend, which tends to stay stable and increase, as was the case with Coca-Cola during the Great Recession years. The stocks Puplava likes best for this purpose are the so-called dividend aristocrats.
Another great option for investors to consider is an annuity, which works similarly to how private pensions used to operate. These pay out a defined income in retirement, and many advisors like them for their predictability.
“What we're doing here versus mutual funds is creating a more predictable string of income that grows over time,” Puplava said. “If you're in an ETF or a bond fund or a stock fund, you can’t predict what your income is going to be today or what it's going to be 5 or 10 years down the road. … When you become fortunate enough to accumulate enough assets, there are absolutely better alternatives.”