Investors spend their whole career skrimping, saving, and investing for retirement. Once you actually retire, though, it's a whole new ball game, and the question becomes how you can get the cash flow you need to survive without a paycheck.
One recent financial innovation is the managed payout mutual fund. These promise to pay you a steady, regular stream of income from your investments, regardless of the income or capital gains those investments produce. Although that kind of security sounds exactly like what crisis-frazzled investors want, does the strategy really work, or is it masking a bigger danger that smart retirees need to face sooner than later?
How payout funds work
As their name suggests, managed payout funds have money managers who try to invest fund assets in such a way as to generate returns that will finance fixed payouts back to shareholders on a regular basis. You can find a variety of payout funds, with companies like Charles Schwab
Depending on the particular fund you choose, the amount of income your fund pays out to you may differ greatly from what other funds pay. In addition, most funds adjust the payout on an annual basis, so what you receive one year may be more or less than you get the next.
For instance, the Fidelity Income Replacement 2030 Fund is designed to pay regular income over the next 20 years, targeting monthly payments that will rise steadily with inflation, and ending the time period with nothing left. Based on its current projections, if you invest $100,000 in the fund, you'll receive $549 per month this year, with payments in future years dependent on inflation levels. But because the fund's Smart Payment Program recalculates payments annually based on percentage of fund assets, a big loss this year can push next year's payment amount down sharply.
How they've done
Unfortunately, the market hasn't been kind to payout funds recently. Fidelity's 2030 fund, for instance, is down 2.3% annually since it opened in late 2007, with a big loss of 26% in 2008 that was only partially offset by gains last year. As a result, payments fell in 2009 but rose this year. Other funds have had similar experiences, showing that the stability retirees hope for isn't necessarily what you'll find from payout funds.
So, if you really want to lock in income, what other choices do you have? Consider the following:
- Immediate annuities are designed to guarantee you a fixed stream of income for the rest of your life. Payout funds require you to pick either a target date when payments will end or a payout rate that could deplete your assets before you die. Annuities eliminate that risk, but on the other hand, unless you structure them otherwise, some annuities pay nothing to your heirs after you die, even if you only take payments for a short time before your death.
- Extremely high-yielding dividend stocks certainly pack a wallop when it comes to providing income. Shipping company Frontline
(NYSE: FRO)and mezzanine capital provider Apollo Investment (Nasdaq: AINV)have implied forward dividend yields of 9% and 11%, respectively, based on their most recent payments. But take a look at their dividend histories, and you'll notice there's a lot of variation among payout amounts. That may not meet your long-term needs.
- A better bet may be lower-yielding stocks that have grown dividends consistently over the years. Sherwin-Williams
(NYSE: SHW)has a 30-year track record of annual dividend growth, with payouts growing at a 14% clip over the past five years. Master limited partnerships Enterprise Products Partners (NYSE: EPD)and Kinder Morgan Energy (NYSE: KMP)not only have dividend yields above 5% but have been steadily raising their payouts for more than a decade. Rising dividends mean that even if the value of your shares goes down, you'll still get a bigger dividend check from year to year. That's the kind of consistency you really need.
The big picture
In the end, managed payout funds serve a useful purpose for some investors. But they won't solve all your income problems. If you combine smart income-producing strategies like annuity products and dividend stocks with a managed payout fund, though, you can put yourself in position to make the most of your retirement savings.
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