Getting your portfolio ready for income

Just like you have to get yourself ready for retirement, you have to get your portfolio ready for retirement too.  In most cases, this means getting your portfolio ready for income by making sure you have appropriate investments inside the portfolio.

The best time to retire

I’ve always said the best time to retire was back in 1981.  Why?  If you retired then, you could head to the bank and invest all of your retirement savings into a good old fashioned GIC at 12% to 19% guaranteed with no risk.  At those interest rates, you could live off the interest and your capital would be guaranteed.  You would never have to look at a statement and see negative returns.  Ahhh . . .  the good ole days!

Unfortunately, those days are long gone and today with really low single digit returns, most retirees can’t imagine living off the 1% to 3% returns that GICs are offering today.

As a result, most retirees are faced with diversified portfolios of different types of investments like mutual funds, stocks, managed portfolios and other non-guaranteed investments.  As many of you know, these investments have created a different set of problems.  I’ve talked to so many people in the last 10 years who delayed retirement because their portfolio dropped 20% to 30% months before their retirement date?  And then there’s others who retired but then had to go back to work or stop their income because their portfolios dropped suddenly after they retired?

With low guaranteed returns retirees have more money invested in investments that provide variable returns.  I’ve talked to many retirees who feel retirees are damned if you do and damned if you don’t.  So how do retirees get their portfolios ready for retirement?

Variable return problems

Too much money in fluctuating investments can result in a deterioration in the longevity of your assets.  In other words, too much risk while you are withdrawing money can result in running out of money a lot faster.  This concept was covered in an article I wrote on how Variable Returns can work against you in retirement

A simple solution

One of the simple solutions to getting your portfolio ready for income and therefore ready for retirement is to make sure you have a portion of the portfolio invested in safe, conservative, low risk investments that can pay you and income for a pre-determined period of time.

My unsophisticated rule is to use the Rule of 5.  Here’s an example to illustrate how it works.

Peter is 65 years of age and has a few minor health issues.  He has a pension, took early CPP and is now has just started collecting OAS.  He has $100,000 in RRSPs he would like to use over the next 10 to 12 years.  As a result, he plans to take out $9000 per year until the money runs out.  His financial advisor told him that was an aggressive withdrawal rate.

If the advisor leaves the money invested in a balanced diversified portfolio, there is a risk that systematic withdrawals can create bad timing risk.  In other words, Peter could run out of money faster if he continues to take out money after a significant drop in the portfolio.

The rule of 5

To get the portfolio ready for this aggressive income, my rule of 5 suggests that he should take the annual income desired from the portfolio ($9000) and multiply by 5.  That comes out to $45,000, which is the amount of money in the portfolio that should be invested in safe conservative investments.  The rest of the money can be invested in higher risk investments to try to earn a higher rate of return.

Related article:  A simple guide on guaranteed investing

The rationale behind the rule of 5 is that keeping $45,000 in safe investments, guarantees Peter 5 years of income.  Even if the $55,000 drops in value, he will not have to withdraw that money because he has set aside enough money to guarantee himself 5 years of $9000.

Why 5 years? 

It’s simply because markets will usually bounce back after corrections within a 5 year period.  If you happen to be more pessimistic, then you can increase the number from 5 to 6, 7 or 8 years.

This strategy is an adaptation of the bucket strategy.  In this example, there’s two buckets.  One with $45,000 that will specifically pay income for 5 years.  The second bucket has $55,000 invested with some growth in mind.  The buckets have to be monitored regularly.  The goals is to fill the second bucket by growing the investments.  As this second bucket grows, it can be used to fill up the first bucket.

Related article: Creating income with the bucket strategy

There may be times when the second bucket is not filling up (investments are not doing well), there should be enough money in the first bucket to pay income.

Other ideas?

Getting your portfolio ready for income is an important step in retirement planning.  My rule of 5 is just a simple strategy to help answer the question “How much money should be invested conservatively?”  What do you think of this strategy?  Do you have any other ideas or suggestions on how to get a portfolio ready for income?

Written by Jim Yih

Jim Yih is a Fee Only Advisor, Best Selling Author, and Financial Speaker on wealth, retirement and personal finance. Currently, Jim specializes in putting Financial Education programs into the workplace. For more information you can follow him on Twitter @JimYih or visit his other websites JimYih.com and Clearpoint Benefit Solutions.

7 Responses to Getting your portfolio ready for income

  1. If you are a long term DIY investor or retired whose aim is safe income that increases with inflation you should seriously consider a portfolio of dividend growth stocks.

    There are 52 U.S. companies alone that have raised their dividends consistently for 40 or more years. The Canadian market is much smaller but 30 companies have raised their dividends for 10 or more years. Of course there are risks involved with DG investing. No one company is immune from a dividend cut, elimination or freeze.

    The safety is in numbers. I have over 25 DG stocks in my RRSP and monitor them for dividend consistency. My plan is to eliminate any stock that cuts it’s div (or if it’s fundamentals change) and replace it with another on my watch list. I’m retired now but still accumulating DG stocks for a few more years so currently my dividend income is reinvested in more stock. In a few years I plan for this growing income to supplement my company pension and CPP.

    This style of investing isn’t for everyone but has served me very well for about 6 years now.

  2. income investment? man, there’s absolute no easy way. those interests senstive stuff like REIT, bonds, are almost done. look what had happen in this Aug, 400 milo cash out… only 40 milo went to equity…
    to me, get some dodfx and brsix instead

    • dodfx and brsix are very volatile but if held over the long term have decent performances. They would be suitable for a young investor with a long time frame until retirement. Just beware of the rock ride along the way.

  3. Like your rule of 5, Jim, for its simplicity and risk management. Also believe strongly in some dividend income especially for its tax efficiency (Cdn. Dividends) and growth potential. Anyone without some guaranteed source of income in retirement like a pension, could also consider using a portion of their funds to purchase an annuity. My own personal philosophy is a little bit of several income sources with a view to tax efficiency makes good sense.

    • I always here negative comments about annuities. Do you have any and if so what type and who with if you don’t mind sharing.

      Bud

  4. Hello Jim, I like your Rule of 5 and your Bucket strategy. My problem is that my portfolio which consists mostly of dividend-paying stocks (my stocks are in: 2 banks,3 oil and gas, 4 metals, 1 REIT, 1 telecom and 2 techs), and a mutual fund, is not doing well. Before the year ends, I’m almost tempted to get rid of some of my losing stocks and use the proceeds to use your Rule of 5. What can you say to this? Thank you so much. Your write-ups are extremely helpful and very educational.

  5. A portfolio ready for income, the Rule of 5

    Most of us retirees need cash regularly. Most of the 60% of working Canadians who don’t have a company or taxpayer funded retirement fund also need cash, sometimes immediately.

    So most of us need cash. Most of us lack the time or the inclination to actively manage their portfolio or pick the right financial advisor or Mutual Fund.

    Many Fund Management companies have a variety of funds, some for the very rich, some available on the TSX.

    Some of these companies manage Closed End Funds, available on the TSX, that pay cash, monthly cash. The Funds vary in their mandate, similarly to some of the Mutual Funds they and others manage. These companies offer news releases and other information via email.

    Some Closed End Funds have a single objective, mandate: to pay monthly cash.

    For retirees, cash is an obvious need.

    For those building their retirement capital, cash is very useful. They can invest in their TFiA (it’s an Investment account, not a Savings account), where they have 3 main options:
    1. accumulate the cash to buy more Closed End Funds to generate more cash
    2. take out the monthly cash, put it in an RRSP where can also buy Closed End Funds
    3. accumulate the cash to build a liquid emergency fund

    How conservative are these Closed End Funds? Look them up. Everyone’s perception of peace of mind is different; look these fund up, make up up your own mind.

    Start with 1% of your weekly time… About 1 hour a week. If you like money, you’ll be motivated to learn more about these cash producing investment vehicles.

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