How Should You Fund Your Retirement Spending?

by | Nov 29, 2021 | Retirement Planning, Smart Financial Tips

As a planning-centric firm, we talk to clients often about spending strategies in retirement.  One that comes up often is the concept of living off portfolio income.  This isn’t all that surprising since this is talked about endlessly in the media.  If you do a quick online search, you will find hundreds of articles talking about this specific topic.

Living off portfolio income sounds like a safe and sound strategy, but there may be some underlying risks with this approach that you may not realize you’re taking.  We believe there is a better way to approach income in retirement–it starts with a sound financial plan and incorporates reliance on the growth of your portfolio in addition to the income.  This concept is known as a total return approach to managing retirement income.

Before we dig deeper into these two approaches, it’s important to keep in mind that it’s imperative that your investment plan fits well with your overall financial plan.  It’s difficult to determine what investment strategy will work best for you without first understanding your overall financial situation and goals.  A financial plan will help you understand what your financial capabilities are based on the assets you have accumulated, your sources of income in retirement, and your projected spending.  This will also help you figure out how much you will need to draw from your portfolio to meet your spending needs.

When it comes to spending in retirement, you also need to be thinking about your overall financial goals.  By far, the most common goal is simply to maintain your current lifestyle throughout retirement and not have to worry about running out of money.  In addition, people want to feel secure and not have to worry about where their next “paycheck” is coming from.

The goal is not to maximize portfolio income; it’s to live the rest of their lives comfortably, so that is what we focus on.  We create a plan that is customized to the client’s situation and then determine what level of risk is needed in their portfolio to give them the best chance of long-term success.

Living off your portfolio income is just what it sounds like–you use the income your portfolio generates, whether from stock dividends or bond interest, to provide your retirement spending.  With this method, you theoretically never sell any of the holdings.

While this may sound appealing, it can have various unintended consequences.  In order to meet spending needs, this strategy typically consists of constructing a portfolio of dividend-paying stocks and long-term and high yield bonds.  We commonly see portfolios concentrated in certain areas of the markets and have little to no allocation to areas that should be included, such as small cap and emerging market stocks.  This method can easily leave you with a portfolio that is poorly diversified, and you may end up taking on more risk than you are comfortable with to achieve the amount of income you need.

Another issue with this approach is that the amount of income generated will fluctuate with changes in interest and dividend rates. This may not fit your overall spending plan very well given that your monthly expenses likely won’t fluctuate much in retirement.  To make things worse, you may feel the need to shift your asset allocation towards higher yielding assets in a low-rate environment which could lead to taking on additional risk in the process.

Investors also may not realize how large a portfolio they will need to produce the amount of income they are looking to generate.  Bonds haven’t provided much of a boost recently, with the yield on the 10-year Treasury below 3% for most of the last 10 years and around 1.60% currently.  As for stock dividends, yields aren’t what they used to be, as shown in the chart below.  If you assume an average dividend yield of 2%, you would need $2.5M invested in these stocks alone just to produce $50,000 annually.


On the other hand, a total return approach to investing incorporates the income of a portfolio as well as the potential growth of the underlying assets.  This method allows you to construct a well-diversified portfolio at a level of risk that closely matches your risk profile. Dividends and interest remain prominent components of the total return approach, but when there is not enough income to support your spending needs, the portfolio is rebalanced to raise enough cash to cover them.  The total return approach helps enable you to match your spending plan consistently as opposed to a variable income stream from dividends and interest.

You may also lower the tax bill on your taxable accounts by shifting the focus of your portfolio from income to growth due to the more advantageous long-term capital gains rates.  When you sell appreciated investments that have been held for more than one year, you will pay long-term capital gains rates on the growth rather than ordinary rates that apply to interest and non-qualified dividends.

A total return approach has the advantage of being aligned with your overall financial plan, allowing you to allocate your portfolio over a broad range of market sectors, as opposed to just income-producing ones, reducing volatility.  Periodically rebalancing the portfolio allows you to meet cash flow needs from wherever gains in the portfolio have occurred.

The best way to plan for retirement is to work with a fee-only CFP® professional. A CFP® professional will help you understand your overall situation and determine what portfolio strategy will give you the best chance of long-term financial success.

Team    Hewins,    LLC    (“Team    Hewins”)    is    an    SEC    registered    investment    adviser;    however,    such  registration  does  not imply a certain level of skill or training, and no inference to the contrary should be  made.  We  provide  this  information  with  the  understanding  that  we  are  not  engaged  in  rendering legal, accounting, or tax services. We recommend that all investors seek out the services of competent professionals in any of the aforementioned areas.