Retirement Planning Made Easy | Seeking Alpha

Co-produced with PendragonY.

A review of discussions about ​retirement planning reveals a significant amount of confusion. It seems that even the definitions of some basic terms are not well understood. Despite a flood of articles, most prospective retirees remain uncertain about what their next steps should be.

Part of this confusion is caused by financial experts. You can easily find experts that will give you very different answers to each of these questions. This isn’t because anyone is giving out incorrect answers but rather because they quietly embed assumptions of their favored strategy into their answers. There is more than one “right” way to manage your retirement. What matters most is that you find a way that works for you.

At HDO, we advocate using what we call The Income Method to generate immediate income from our portfolios to cover retirement expenses. Today, we will review the basic questions many prospective retirees have – how The Income Method addresses them will help reduce this confusion.

I’ll try to separate how The Income Method helps address these questions, versus the more general answers usually offered. Also, keep in mind that these answers are opinions, like all answers to these questions, but opinions based on my experience as well as that of other HDO contributors.

How Much of Pre-retirement Income Should You Aim to Replace?

A lot of retirement planning advice tells people to aim to replace 70% or 80% of their pre-retirement income in retirement. Their premise is a reduction in expenses you will have because you are no longer working. They focus on the lower need for expensive work clothes, the ability to eat lunch at home, or even the fact that you won’t be commuting to work each day. Once you retire, a lot of work-related expenses disappear. Also, you hopefully made progress reducing or eliminating personal debt like student loans, credit cards, car loans, and even your mortgage.

Yet there is one huge thing that most advisors ignore, probably because they are all still working. They ignore all that time you will now have on your hands. The time that used to be spent earning money will now be devoted to other activities. Activities that will often cost money rather than make it.

We recommend that you plan for at least 100% replacement of your pre-retirement earnings. Do you really want to reduce your lifestyle or constantly worry that an unexpected expense will destroy your portfolio? You should aim higher than you strictly “need” just to get by.

You didn’t work for many decades just to “get by.” While it is good to be frugal, there is no sense in being so frugal that you can’t have fun too. After years of hard work, you can then have fun rather than worrying about pinching pennies.

Once you start collecting Social Security, that will cover something like 30% to 40% of your pre-retirement income. Your portfolio will need to cover the other 70%. A reasonable level of savings and a well-chosen portfolio should be able to do that. The Income Method focuses on providing immediate income, which makes it easy to figure out if your portfolio is ready for your retirement.

Does Spending Decline In Retirement?

A lot of surveys seem to indicate that spending will decline in retirement. Maybe, but I wouldn’t count on it. Your spending might vary as a retiree. Initially, you might want to travel a lot. But as you get older, you might not want to do as much traveling. At the same time, medical costs will increase. Maybe you will travel less, but you will help out your children or grandchildren more.

It isn’t prudent to count on spending to decline. That roof just might need to be replaced, maybe you will want a newer car, or maybe you will take up a hobby that costs a bit.

When you are retired, your essential spending might decline, but you want to have a healthy excess for discretionary spending.

What is Discretionary Spending?

Extras. This is spending that you have the option of doing or not. Nothing bad will happen if you don’t spend money on these. So it’s not the rent or mortgage or the electric bill. Rather, it’s the golf trip to Myrtle Beach; discretionary spending is composed of travel, hobbies, dining out, and entertainment. It is what makes life enjoyable. Helping your children is also discretionary (even if you feel a lot more pressure to help them than you do about taking that golf trip to Myrtle Beach).

Plan to have the money to spend on these extras – it will make for a much happier retirement. With its focus on immediate income rather than capital gains, The Income Method will tell you exactly how much money you have to spend on these extras.

Do You Need to Keep A Detailed Retirement Budget?

“Maybe, yeah” isn’t a common answer. Plenty of analysts will assure you that a detailed budget is an important requirement. Others will tell you that you know your basic expenses and that a detailed budget won’t tell you anything you don’t already know.

Some people need a budget to help them control their spending. If they don’t have a detailed budget, any new shiny thing will be bought until the money runs out. Others know what they have to spend and make good decisions without a specific line item in a budget.

How do you budget now? If you are on track, paying your bills, and still saving money for retirement, you don’t need our advice. You’ve already found a budgeting system that works for you. Keep doing it.

Retirement advice often suggests you need to “do something different” because you will be on a “fixed income,” and you need to determine how much you can safely take out of your portfolio. Well, guess what? Most of you have been on a “fixed income” most of your life. It isn’t like you could walk up to your boss and say, “Um, yeah, I overspent on my credit card last month. Can you pay me an extra $1,000?” You had an income, and it was relatively predictable. Those of you who worked for commissions or owned your own businesses which had variable cash flow might have frequently wished for a “fixed income,” as variable cash flow makes budgeting much more challenging.

Using the Income Method, you are still getting a relatively predictable income. Dividends and interest will come into your account every month. You will know approximately how much is coming and when, just like when you were working. If it ain’t broke, don’t fix it. Your budgeting strategy is apparently working, so keep doing that. The only difference is that instead of a paycheck, your source of income will be dividends.

Is Inflation a Big Deal for Retirees?

Yes. Inflation has been low for a long time now. So it might not be so obvious that inflation is a big deal. There is a reason why it is called the silent thief, and with inflation spiking so high recently, it is an even bigger issue.

Inflation is a big deal for everyone. But even more so for retirees. When you aren’t retired, you can expect the income from your job to increase each year with inflation. Perhaps it might not entirely keep up with inflation, but you will get an increase each year. Well, with your investment portfolio, that isn’t guaranteed to happen.

The Income Method aims to generate more income than you need to so that you can use some of it to buy more shares that will pay you more income in the future. This is another reason why we recommend 100% replacement. One item often left out when recommending replacing less than 100% of your pre-retirement income is the assumption that you will not need to save once you retire.

Does This Mean Retirees Need to Continue Saving?

Yes!

The fact is that saving is still prudent once you retire. There is a lot of talk about people in retirement being on fixed incomes. But that just isn’t the case. Social Security is indexed for inflation, so it isn’t really fixed, and savings gives the retiree an important tool for generating more income. With The Income Method, those savings are used to buy more shares which help with increasing your income.

You spent your working life setting aside money for the future. Even though you stopped working, you still have a future! I like to recommend planning on reinvesting at least 25% of your dividends. When you are achieving yields of 8-10%, it is very reasonable to have enough excess to reinvest. This will cause your income to increase, often at a pace that exceeds inflation. Plus, it gives your income a cushion in case dividends are cut or a bond you own defaults.

Will Seniors Really Spend $300,000 on Healthcare in Retirement?

Health expenses will be a significant cost in retirement, and medical needs will vary with each retiree over time. This $300,000 number is based on a 30-year projection of Medicare and Medigap premiums and co-pays. How much will you spend? Nobody knows, but as you age, you can expect the number of health issues you have will likely increase. You can expect your cost for healthcare to increase over time.

How Big a Risk is Longevity?

The longer you live, the longer you are expected to live. Average life expectancy increases as you age because the average includes people who will die at less than the average. At 65, the current average life expectancy of a man is 84, but at 75, it has increased to 87. Women see a similar increase.

More life means both more inflation and more chances for unexpected expenses. The older you get, the more difficult it will be for you to decide to return to work. You don’t want to be 90-something looking for your first job in 20+ years because your retirement ran out.

The Income Method avoids selling off your assets to fund expenses. This provides protection from running out of money because instead of selling off stocks to fund your lifestyle, you are buying more stocks every single year. You are living off of a portion of the dividends you receive and reinvesting the rest. You will know, every year, exactly how much income you received. Any dividend changes will be seen immediately. So you will know how much to budget.

This is where I believe the Income Method is much more practical than other strategies. The stock market indexes have been down 20-30% all year. So do retirees sell more shares to fund their withdrawals, shortening the life expectancy of their portfolio by selling at low prices? Or do they cut their budget 20-30%? Or something in-between. These are tough decisions, because nobody knows for certain if the market will rally right back next year, or keep going down.

How is our income doing? It is up this year as we have seen dozens of dividend hikes throughout our portfolio. Plus, if you have been reinvesting as the plan calls for, you are buying at lower prices and higher yields. Our incomes are not down 20-30%, they are growing at a healthy pace thanks to low prices!

What About the 4% Rule?

Much ink has been spilled writing about safe withdrawal rates and what has been called the 4% Rule. But it was never really a rule, but rather a guideline based on the maximum safe withdrawal amount without running out of money over a 30-year retirement, from a portfolio composed of stocks and bonds and using capital gains strategies.

That 4% was based on relatively high bond interest rates. So many people now talk about a 3.5% or even 3% safe withdrawal rate. However, there are two risks for retirees in my eyes. Taking out too much is the focus because running out of money is a disaster. However, too many retirees live in fear. They don’t take out enough!

Backtesting the 4% rule, the retiree could have taken out substantially more without fear most of the time. Even with the 4% rule, 3% of the time, the portfolio didn’t survive 30 years. Call me crazy, but I don’t want a 3% chance of running out of money.

You want to ensure your portfolio will survive indefinitely. But on the other hand, you don’t want to unnecessarily rob yourself of spending money. You worked hard, you earned your money, and you shouldn’t be held back from enjoying the fruits of your labor!

What about The Income Method?

The Income Method doesn’t depend on regular sales of shares to produce the cash to fund retirement. So in many ways, it is a lot easier to manage than strategies that rely on capital gains for some or all of their cash.

The HDO model portfolio targets an average yield of around 8%-10%. We recommend using 25% or so of your income stream to buy more shares and help reduce the impact of inflation on your income stream’s purchasing power. So even at 8%, that will leave you 6% of your portfolio each year to fund your retirement. This means you can meet your retirement income needs with a smaller portfolio (or have a safer nest egg with much more income than you need).

Forget trying to predict the future. Focus on your income right now. How does the Income Method work?

1. Create a diversified stream of dividends and interest: We recommend investing in at least 42 different income-producing investments in a variety of sectors. That is a minimum, not a limit! By diversifying your income streams, you protect yourself from a single source disrupting your income. There is always a risk that your income is disrupted. In your working years, you had the risk of being fired, laid off, being forced to take off time for an injury, or other disruptions to your income. Odds are, you had to deal with something in your lifetime. Back then, you had one income source, so it was a huge impact when something happened. When you are retired, you can have dozens or even hundreds of income sources!
2. Reinvest at least 25% for income growth: You want your income to last forever, and you want to protect yourself from inflation. Earmarking at least 25% for reinvestment will ensure that you are always buying more shares and will help ensure that your income keeps growing. Even during “black swan” events like COVID or the Great Financial Crisis, reinvesting can help keep your overall income climbing.
3. Actively manage your portfolio to grow your income more: Reinvesting is not the only way to grow your income. The reality is that stock prices move a lot. Companies might be high-yielding one year but low-yielding next year as their price climbs. Taking time to realize gains in companies that have become popular, and reinvesting in higher-yielding options, can greatly increase your income. We look at every trade with an eye on how it impacts our income. As a result, our income grows faster.
4. Do your due diligence: Dividends and even interest payments from companies are not guaranteed. When you are managing your own portfolio, it is essential you do your “due diligence” and buy companies that will be able to meet their debt obligations and will be able to support their dividends. Due diligence can be time-consuming but is an essential part of managing your retirement. Fortunately, there are many places you can go to get the tools you need to help you do your diligence more quickly and effectively. I’m a bit biased, but right here on Seeking Alpha is one of the best places to start!
5. Enjoy your retirement! Once you set up your income stream and have it coming in, you can step away from the day-to-day drama of the market if you wish. Stock market prices change dramatically every time a Fed official opens their mouth, some billionaire sends a tweet, or some economic metric differs from “expectations.” Follow the drama if you wish, but the real beauty of income investing is that you don’t have to. The only news you need to worry about is the news that impacts your income. Most of the drama doesn’t. Your income will keep coming in as the lemmings in the market chase each other up and down.

Conclusion

There is a lot of confusion around retirement planning. Many retirement advisors are less focused than they should be; others offer advice tailored to total return or capital gains investing, which can be devastating in bear markets like we are seeing today.

For retirees or those planning for retirement, a focus on income investing can clear up some of a lot of confusion. It can give you peace of mind knowing that you get a recurring paycheck no matter how the markets are doing. Dividend Investing and “The Income Method” can also help by making some retirement planning less complicated and more enjoyable!