Having a plan for your retirement income is very beneficial. Understanding the difference between accumulating vs versus distributing retirement funds can help you figure out how long your income will last for you. Scott Peterson covers fixed-income investments and rising-income investments and emphasizes when you should be utilizing each.
At retirement once you have made thoughtful decisions about how to get the most out of your Social Security and pension, the balance of your retirement income will have to come from your investments. The distribution of your investments will need to be coordinated with these other streams of income for tax purposes, as well as to help you stretch your income out to last a lifetime.
We liken the accumulation and distribution of retirement funds to what a skier experiences at a ski resort. Riding the chairlift up the mountain is the easy part of skiing. It takes no skill, and even the most inexperienced skier can ride the lift without running into too many difficulties. The skier simply must stay on the lift and they will get to the top of the mountain. Just a warning: abandoning the lift could prove to be fatal.
Having a 401(k) is like riding the lift. A certain percentage of the worker’s check is systematically deducted by an employer, oftentimes matched, and then deposited directly into an investment portfolio. It is easy, even automatic. But, as abandoning the ski lift could prove to be fatal, not participating in a 401(k), or failing to invest into an IRA, will have catastrophic consequences.
New skiers once off the lift, are bound to have difficulties. Getting down the mountain can turn into a frustrating and even a dangerous endeavor to the novice skier. Help from an experienced instructor is invaluable.
Likewise, new retirees often make mistakes as they begin retirement, crashing, so to speak, as they make poor choices regarding their Social Security and pensions benefits. These mistakes can be compounded if investment accounts are not properly managed and distributed. The key is choosing a proper mix of investments and then properly liquidating those investments to provide an income stream that will last throughout retirement.
Accumulation Vs. Distribution
So, why is distributing retirement funds so much more difficult than accumulating funds? One only must go back to the decade 2000-2010 to understand how volatility in the stock market impacts the accumulator, versus someone who is retired and is distributing retirement funds. 2000-2003 were awful years for equities. The stock market declined by 49% before recovering. From 2004-2007, the stock market finally gained some momentum, then the worst market downturn since the Great Depression occurred in 2008-2009 (declining by 57%). The net result for the U.S. stock market was that it ended the decade in 2010 at about the same level as it started in 2000. Ten years without growth.
You might ask, how did this volatility and ten years of no growth affect the accumulator? Well, it was a wonderful blessing! Those of us who were systematically contributing to 401(k)s and IRAs from 2000-2010 were able to purchase greater quantities of equities as the price of stocks plummeted during the decade. Certainly, our account balances suffered temporarily, but as the share prices dropped, the number of shares we were able to purchase rose as we systematically purchased beaten-down shares of stock month by month. Once we had accumulated a bunch of cheap shares over the decades, the stock market shot up to record highs. Those downtrodden stocks we purchased so cheaply during the “lost decade” have now caused our account balances to explode with value.
Contrast this with what happened to the unfortunate retiree who was distributing investments during the first decade of the century. Many of those investors were forced to sell their equities at the worst possible time. They had no choice; they had to sell at a loss to provide the income necessary just to pay the bills. Many well-funded retirement accounts were devastated during this turbulent time.
Systematic purchasers of equities do well investing in volatile, down markets, while systematic liquidators of equities are crushed during down-market cycles. During 2000–2010, buyers were blessed, and sellers suffered. This decade perfectly illustrates the difficulty of accumulating retirement funds versus simply managing and distributing retirement funds. The good news is that there are plans that can be implemented to help protect future retirees from having to liquidate equities at a loss to create income, should you be unfortunate enough to begin your retirement at the beginning of a bear market. The Perennial Income Model which we created is such a plan and is further explained in other blog posts and in the video below.
The Need for Growth
Given the history of 2000-2010, you may think that you will just avoid equities altogether, so you will not be forced to liquidate those volatile investments in a down market. That will not work. Keeping ahead of inflation is essential to having enough income to last throughout retirement and equities are one of the few investments that will be a necessary component of your portfolio.
As we see things, there are only two categories of investments: fixed-income investments and rising-income investments. Fixed-income investments are characterized as slow-growing and non-volatile investments such as bank deposits and certain types of bonds. Certainly, there is an appropriate time to own fixed-income investments. They should be the investment of choice when you have a limited time for your money to grow (less than five years) and you can’t afford to wait out a stock market correction. Fixed income investments protect us from short-term volatility but are damaging to own over the longer term, as they offer little protection against the erosion of purchasing power.
In the long run, the only rational approach to protect against the erosion of purchasing power is to invest in rising-income type investments, in other words, owning equities. As a shareholder, or the partial owner of some of the greatest companies in America, you have the rights to the profits those companies make. These companies pay their shareholders their proportional share of the profits in the form of the dividends. Historically, the dividend rate of the greatest companies in the world, or the S&P 500, has increased about one and a half times faster than consumer prices have gone up. In other words, their dividends have managed to stay ahead of inflation. Besides the growth of dividends, historically, stocks have additionally experienced a tremendous amount of growth in their value.
Stocks, Bonds, and Compound Interest
Government bonds are the classic fixed-income investment. They are very stable and are backed by the federal government. For the last thirty years, these bonds (as measured by the ten-year treasuries) have had an average annual return of about 5%. If $100,000 were to have been invested into these bonds in 1987, the value of that investment would be $460,000 today.
Meanwhile, stocks, the classic rising-income investment, have averaged more than 10% during the same time. $100,000 placed into an investment that mirrors the S&P 500 for the past thirty years would be worth $1,650,000 today. Inflation-beating growth is necessary to maintain your purchasing power over retirement, and that kind of growth is achieved by investing into equities.
When you purchase a share of stock, you become a partial owner of the company whose stock you purchased. As an owner of the company, you are entitled to all the profits and growth associated with that company, according to the proportional amount of the company that you own.
Land, cars, homes, and essentially anything that can be bought and sold on the open market will have a price that fluctuates. Buying and selling partial ownership or shares in corporations is no different than buying and selling anything else, but somehow the simplicity of the concept is lost when it comes to buying shares of stocks.
Far too many times we have had people tell us after a market downturn that they were not going to buy equities until things stabilized a bit and prices rebounded. That is like saying, “I’m not interested in buying that cabin for a 30% discount; real-estate prices are just too uncertain. When cabin prices stabilize, and the price goes back up 30%, I will write you a check.” We wouldn’t conduct any of our other business in this manner. Why do we treat our equity purchases differently?
Certainly, the daily selling prices of corporations fluctuate, but being an owner of a diversified portfolio of these corporations over a long period of time has been and will continue to be the recipe for success. The key to investment success throughout retirement is to have a plan. A plan that overcomes the effects of inflation as well as takes into account the occasional bouts of stock market volatility. You need a plan that matches your current investment portfolio with your future income needs.
If you are getting close to retirement and will have at least $500,000 saved at retirement, click here to request a complimentary copy of Scott’s new book!
Scott is the founder and principal investment advisor of Peterson Wealth Advisors. He graduated from Brigham Young University in 1986 and has since specialized in financial management for retirees. Scott is the author of Maximize Your Retirement Income and Plan on Living: The Retiree’s Guide to Lasting Income & Enduring Wealth.