Living in Retirement

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For retirees, low yields may mean the future ain't what it used to be

August 15, 2013

After decades spent trying to save up enough for retirement, many new retirees face a very different concern: How much to spend? The question is especially challenging now that bonds, a traditional staple of retirement portfolios, are providing historically low levels of income. Thankfully, you may have more tools in your retirement toolbox than you thought.

4% is still a ballpark figure—maybe

For more than a decade, the rule of thumb offered by many financial planners has been to spend about 4% of your retirement portfolio's assets in the first year, and then the same amount adjusted for inflation every year after that. Some assumptions underlying the advice are that the investment time horizon is long-term (more than 25 years) and that the portfolio remains broadly diversified with a mix of stocks and bonds.

Colleen JaconettiYou might be able to spend more than that if you plan to work past age 65, because you may then have a shorter period in retirement. You might need to spend less than 4% if you're unlucky enough to retire at the beginning of a downturn in the stock market, which would dampen your stock returns in succeeding years. But for many retirees, 4% probably remains a reasonable place to start, according to Colleen Jaconetti, a senior analyst with Vanguard Investment Strategy Group. She points out that it is an approximate figure and doesn't take taxes or other investment costs into account.

"Only spend what you earn" isn't working

Not so long ago, withdrawing that 4%-per-year was straightforward for retirees. Using an income-only approach, they could simply dip into the cash their investments had produced through stock dividends and bond coupon payments to meet their expenses. As the accompanying chart shows, a diversified portfolio made up of 50% stocks and 50% bonds would have produced enough income to cover the 4% spending rate (shown in gray) well into the late 1990s. In many years, there was even income left over to reinvest.

A traditional retirement portfolio: Steady spending rate versus a steady slide in yields

December 1, 1979–December 31, 2012

Traditional retirement portfolio

Note: Portfolio yield is based on the dividend yields of the S&P 500 Index and the MSCI US Broad Market Index and the yield to maturity of the Barclays U.S. Aggregate Bond Index. Source: Vanguard calculations using data from Thomson Reuters Datastream, MSCI, and Barclays. This hypothetical illustration does not represent the return on any particular investment.

But times have changed. Yields now have fallen to historical lows and are widely expected to stay there for some time. The consequence for retirees: The same 50% stock/50% bond portfolio today would provide barely half of that 4% income target. Spending only what you earn is no longer an option—which raises the question, "How do you fill the gap?"

More income may mean more risk

It might be tempting to try overhauling your portfolio to produce more income by dialing up its allocation to higher-yielding investments. Corporate bonds, high-yield bonds, or high-dividend stocks might fit the bill, but keep in mind that adding more of these assets to a well-diversified portfolio also adds risk.

"Retirees spending from income alone might think they're playing it safe," said Ms. Jaconetti, "but moving away from a broadly diversified portfolio in order to do that could eventually result in losses that exceed the amount they picked up in extra income."

Let's say Martha, a hypothetical investor keen to get more income from her portfolio, decides to tilt it toward high-yield bonds. She may get more income to spend, but if she finances the shift by reducing her holdings in investment-grade bonds, she'll likely see more fluctuation in her portfolio's performance and a sharper decline in its value during bear stock markets, because high-yield bonds tend to be more closely correlated with stocks. If she buys them by reducing her stock holdings, she'll likely shorten the time her portfolio will support her in retirement, because over the long term stocks historically have returned more than bonds.

Tapping your capital is an option

Ms. Jaconetti suggests that retirees like Martha consider selling some of their holdings when income alone falls short of meeting their spending needs.

For a more detailed analysis of the total-return approach to spending in retirement, see Total-return investing: An enduring solution for low yieldsPDF

She acknowledges that this "total return" approach, which puts both income and accumulated wealth on the table, is not necessarily easy for retirees to embrace. It's not as intuitive or simple to implement as an income-only approach.

For example, in 2012 a retiree whose 50%/50% stock/bond portfolio would have had a total return of 10.4% would have found that the income from investments (income return) represented 2.7 percentage points of the result.* The remainder—the appreciation from the portfolio's investments (capital return)—amounted to 7.7 percentage points. It's the latter portion of total return that would have been tapped for withdrawal.

Moreover, the total return strategy offers a very important advantage: You don't have to abandon diversification (or the level of risk you're comfortable with) by chasing higher-yielding investments to fund your retirement.

Total return spending can be more tax-efficient as well. The subject is complicated, and everyone's tax situation is different, but let's look at one example of how capital gains on stocks in a taxable account might be a more tax-advantageous resource than dividends.

Suppose George, who falls into the 25% federal tax bracket, puts a big slice of his portfolio into high-dividend stocks because he's starting to feel the squeeze on his retirement income from low yields. He is happy when the stocks produce qualified dividends of $10,000 for the year. After deducting 15% federal income tax on the full amount, George ends up with $8,500.

But what if, instead, he got the $10,000 by selling stocks he had bought a few years earlier for $8,000? George would still have to pay 15% to the federal government, this time as net long-term capital gains tax—but only on the profit of $2,000, which would leave him with $9,700. (State taxes may also apply in both cases.) In this illustration, selling stocks leaves George with $1,200 more to spend after paying federal tax than if he had earned the same amount in dividends.

As the above examples show, although income investing holds the allure of a more generous income stream, it generally comes with more risk and possibly more taxes as well. The bottom line is that there are lots of ways to go astray when spending from your portfolio. You can avoid many of them by keeping your assets well-diversified, being as disciplined about spending in retirement as you were in saving for it, and reassessing your situation from time to time to keep up with how the markets, tax laws, and your spending needs evolve.

*Based on returns for the MSCI US Broad Market Index and the Barclays U.S. Aggregate Bond Index.



  • All investing is subject to risk, including the possible loss of the money you invest.
  • Diversification does not ensure a profit or protect against a loss.
  • Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
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