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In the complicated world of finance, simple rules of thumb can be a godsend. But following the wrong rules can land you in a heap of trouble.
One such rule that deals with how to save for retirement has generated a lot of controversy lately. Yet while the reality is that today's retirees face much more challenging conditions than most would have expected just a few short years ago, you can still find investments that will help you get your portfolio to generate the income you need.
Understanding the 4% rule
For years, financial advisors have hammered an easy-to-follow rule into your brain to make saving for retirement as simple as possible: The first year after you retire, plan to take about 4% of your total nest egg to cover your living expenses for the year. Then, you can adjust whatever dollar amount that calculation produced upward for inflation. According to the rule, you stand strong odds of having your nest egg last long enough to cover your retirement needs for 30 years.
But since the market meltdown of 2008 and early 2009, conflicting studies about whether the 4% rule really works have confused investors. As SmartMoney related last week, one research paper said that the true safe withdrawal rate in retirement was closer to 1.8% in 2010. Yet a competing study said that some retirees might be able to withdraw as much as 7% safely. On a $1 million nest egg, that makes the difference between struggling on $1,500 per month versus living it up on almost $6,000 in monthly spending.
With even experts unsure what to recommend, what are you supposed to do?
The disappearing income trick
Although stock market volatility definitely deserves some of the blame for the difficulty in predicting the financial fate of today's retirees, the bigger challenge comes from the drying-up of traditional income sources. With bank accounts and Treasury bills paying far less than 1% these days, retirees can't draw investment income from their portfolios without taking on risk -- in some cases, far more risk than they should.
For the truly risk-averse, one answer gives you as much certainty as you can get. If you're 65 years old and have $1 million in retirement funds, you can buy an immediate annuity and get annual income of between $60,000 and $70,000 for the rest of your life. The downsides: Your heirs get nothing even if you pass away soon after you spend that $1 million to buy the annuity, and your monthly payments don't rise with inflation. Of course, you can add bells and whistles to your annuity to leave something to your heirs or get an inflation adjustment -- but your initial monthly payment will take a hit.
Maximize your income while minimizing risk
If you'd rather take your chances, though, consider that while dividend stocks are far from risk-free, they do provide you with solid income, even in today's low-rate environment. Moreover, the right stocks actually increase their payouts over time, leaving you with even more income from your portfolio.
For instance, Altria (NYSE: MO ) has raised its dividend annually for 43 years, once you take into account its spinoffs of various divisions over the years. With a current 5.5% yield, you're getting significant compensation for the ever-present risk of tobacco litigation.
Leggett & Platt (NYSE: LEG ) and its furniture and building-products business may not sound like a cash cow, but shareholders would disagree. With a yield of almost 5% and 40 years of dividend increases behind it, the company could also see some big share gains if a business-led recovery takes shape.
To play the trend of worldwide consumer spending, Avon Products (NYSE: AVP ) makes a lucrative choice. The stock yields 5.3%, and the company has increased its payout for 22 years straight while making huge inroads in emerging markets, providing big growth potential that could easily extend well into the future. New blood in the CEO role could also help.
In the energy space, master limited partnerships pay healthy dividends. Enterprise Products Partners (NYSE: EPD ) has 14 years of dividend increases behind it, and with a yield over 5%, it stands to benefit greatly from continued strength in oil prices -- as well as any rebound in natural gas.
Finally, REIT Realty Income (NYSE: O ) has a simple name that says exactly what it does: Collect rental payments from retail occupants of malls and other store properties, and then turn around and pay it out to investors in a monthly check. With a yield of 5% and 18 years of annual increases, Realty Income has weathered the real estate storm with flying colors.
Live off the income
With stocks like these, you don't even need share prices to go up. As long as you get your 4%+ yield and have those payments rise every year, share-price stability alone is enough to cover your 4% target. While you can't afford to ignore the risk that these and other dividend stocks have, they nevertheless can help make a simple rule even simpler.
The right investments are an important part of building a successful retirement. Read this special report from the Motley Fool to get more tips on investing for a richer retirement. It's free but only available for a limited time, so click here and read it today.