Expat Investment Advice: Five Tips to Generate Income from Your Portfolio in RetirementSubmitted by Creveling & Creveling Private Wealth Advisory on August 4th, 2020
By Chad Creveling, CFA, and Peggy Creveling, CFA
One of the biggest financial challenges that expat retirees can face is how to generate a reliable stream of income when they no longer have a regular paycheck coming in. During working years, people tend to focus on saving and reaching a particular dollar target or trying to maximize investment returns. Less thought may be given to how to turn a lump sum portfolio into a sustainable income stream that does not expire before they do.
The challenge is not just mathematical, but psychological as well. It's one thing to experience the ups and downs of the market when you have a steady paycheck to pay the bills and you have years to go before retirement. It's an entirely different proposition to deal with market volatility when you are spending funds drawn from the portfolio. This can be particularly challenging for expatriates who may not be able to rely on national pension and health care schemes.
While each retirement situation is unique, here are some tips to help you construct your own retirement income strategy:
- Set aside a cash reserve: Consider setting aside 12–24 months of living expenses (minus reliable non-portfolio income sources, such as national or corporate pensions) as a cash reserve. You should consider this spent money and hold it in a bank account or money market fund in the currency you will need to fund your living expenses. You're not looking to earn any significant return on these funds. They are designed to fund your monthly living expenses and provide a liquid pool of assets in the event of an emergency while insulating you from the inevitable ups and downs of your portfolio. From time to time, top up this reserve from portfolio earnings and principal. The cash reserve can also provide an important psychological buffer from the volatility of the markets, knowing that you have a year or two of living expenses covered. This will help you stick with your long-term investment strategy when the going gets tough in the markets.
- Don't rely solely on interest and dividends for income: It's a fallacy that you should be able to live on interest and dividends from your portfolio alone, particularly in this low-interest-rate environment. Many people are understandably uncomfortable tapping into principal to fund retirement expenses, where any depletion in the portfolio value, either from spending or market movements, often triggers alarm. The reality, however, is that unless you have a very substantial portfolio or significant other income streams, it will be impossible to live on interest and dividends alone.
An attempt to do so often leads to more risk in the portfolio as retirees hunt for yield in the riskier parts of the investment universe. Alternatively, some are seduced by the false security of less volatile assets, such as cash and short-term bonds. Unfortunately, these assets will never keep up with inflation and virtually ensure you will run out of money over longer retirement periods.
Most retirees will need to follow a "total return" portfolio policy, which taps into interest, dividends, capital gains, and principal to generate their retirement income stream. To minimize the chances of running out of money, many retirees will have to learn to invest a portion in investments that have a chance of generating a higher long-term rate of return and correspondingly accept some level of short-term volatility in the portfolio.
- Plan a reasonable sustainable withdrawal rate: The sustainable withdrawal rate is the amount (percentage) that you can draw annually from the portfolio without running a significant risk of running out of money during retirement. The "4% Rule" is widely touted in financial circles as a "safe" withdrawal rate for a portfolio expected to last over 30 years regardless of the actual economic environment and market returns experienced in retirement. Withdrawal rates of 6% or higher run a serious risk of depleting the portfolio regardless of the portfolio asset allocation over such long time frames.
This is just a benchmark, however, and may have little bearing on a specific retiree's sustainable withdrawal rate. Those retiring in their 50s with potentially 40 years in retirement would be looking at a much lower withdrawal rate. Likewise, expats dealing with emerging-market inflation rates and currency volatility may need to lower their withdrawal rate. On the other hand, a 70-year-old with a shorter time horizon may get by with a much higher withdrawal rate.
- Keep sufficient equity: It's understandable and prudent that retirees try to minimize portfolio risk, but it's important to understand that minimizing one type of risk often exposes them to another. Many investors are disconcerted by short-term market fluctuations, which are a normal part of investing and are necessary to bear in order to obtain longer-run gains. In an effort to avoid the normal ups and downs of the equity markets, many retirees gravitate to cash and bonds with little daily fluctuation in market value. The problem is there is very little growth as well. A 75- or 80-year-old retiree does not need to be so concerned about growth or inflation, but for someone with a 20- to 40-year retirement horizon, inflation is the major risk. To provide adequate growth over longer retirement periods, retirees will need to maintain a reasonable weighting to equities as an inflation hedge.
- Stress test your retirement income plan: The goal of retirement income planning is to generate an inflation-adjusted stream of income that you have little chance of outliving. Since the markets and your portfolio do not generate steady returns like a paycheck, it can often be difficult to figure out how much you can take out of your portfolio each year without running out of money. To determine a sustainable income stream, you should stress test your portfolio over a wide range of potential economic conditions and market return sequences over your retirement horizon. Ideally, this should encompass historical back testing over various economic periods, Monte Carlo analysis and scenario testing where you stress test key variables to your plan. A qualified financial planner can help with this, or you can look for financial planning software and do the analysis yourself. Either way, this type of analysis will be a great help in devising a sustainable income stream as well as providing the confidence for you to stay the course when markets get difficult.
The Key to a Secure Retirement
Creating a realistic and sustainable retirement income stream from your portfolio is one of the most important financial tasks you need to accomplish to ensure a secure retirement. This should not be taken lightly. Without the benefits of time and a steady paycheck, mistakes can be difficult to recover from.
This article is a revised and updated version of ones that have appeared previously on www.crevelingandcreveling.com.
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