For most, it means a transition from accumulating assets (contributing to the 401k, deferring income from bonuses, etc.) to supporting your spending from the portfolio you’ve built. Getting a paycheck from your investments can be done in two ways: 1) By spending investment income (interest and dividends) as you earn it—called an Income Approach or, 2) Through a rebalancing process on your broadly diversified portfolio—known as a Total Return Approach.
The Income Approach is simple to setup and execute but has significant drawbacks. Let’s find out what they are and learn the key to generating a paycheck from your investments via a Total Return approach.
The Income Approach
This method is how many retirees funded their lifestyle in the past. As the graphic depicts, it’s a simple method by which income from one’s investment assets are deposited in a bank account and spent. The naïve approach appeals to some as it’s easy to setup and because the income from bonds is consistent and tangible. However, there are two big problems with this approach:
- You are leaving out a huge number of investment opportunities. By focusing solely on bonds and dividend paying stocks, your portfolio neglects massive chunks of the market and can reduce your returns and increase risk by leaving your portfolio overly concentrated.
- The next issue with an income approach is that yield is quite expensive in the current market environment. Because yields on bonds aren’t what they were a decade ago, you need substantially more in assets to generate the same level of income. For example, to produce $50k of interest income from a portfolio, you would need nearly three times the assets now compared to 2006.
The Total Return Approach
If the income approach leaves us un-diversified AND reaching for yield is there a better way?
Enter total return investing.
Here portfolio returns come from income and dividends sure, but also capital gains. Your paycheck is then generated through a rebalancing process. Through this process, you sell investments which have increased as a percentage of your portfolio and move some of the funds into your bank account to fund your spending. If there is money left over, it’s used to buy assets which are below your target allocation—therefore completing the rebalancing process. Rebalancing not only generates a paycheck in retirement but also reinforces the “buy low, sell high” behavior that is critical to investing success.
The total return approach makes your portfolio more balanced (not concentrated with bonds or high dividend stocks) and by rebalancing, you can get a paycheck from your investments and maintain a well-diversified, balanced portfolio.
Making the decision to leave Intel can be a difficult one. Knowing how you are going to get paid can help ease the anxiety and let you pursue a rewarding “Life after Intel.”
As we just showed, knowing how to get a paycheck is important, but you also should consider from what account to pull your paycheck. In an upcoming article, we will look at “withdrawal order” (the sequence in which you withdraw money from your taxable, tax-deferred, and tax-free accounts) and the significant impact this can have on your portfolio value and the taxes you end up paying in retirement. Stay tuned and consider signing up to receive the blog, so you don’t miss a post.
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