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
Leggett & Platt
To play the trend of worldwide consumer spending, Avon Products
In the energy space, master limited partnerships pay healthy dividends. Enterprise Products Partners
Finally, REIT Realty Income
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.
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Fool contributor Dan Caplinger doesn't need portfolio income right now, but he still appreciates dividends when they come. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Altria. Motley Fool newsletter services have recommended buying shares of Enterprise Products Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy never retires on you.