FINANCIAL EXPERTS often suggest retirees use a 4% portfolio withdrawal rate. For instance, if you retire with $400,000 in savings, that would mean $16,000 in pretax first-year portfolio income. You might be able to generate that income by purchasing a collection of bonds that yield 4%. Problem is, the bonds may be from financially weak issuers and hence there’s a risk of default, plus you would leave yourself vulnerable to inflation, which will reduce the purchasing power of your bond interest with every passing year.
To fend off the threat from inflation, you might allocate part of your savings to stocks, which have the potential to deliver long-run inflation-beating gains. But that creates a new set of headaches, because you will likely have to cope with nasty short-term market declines.
What to do? Instead of investing for yield, try aiming for a healthy total return through a combination of interest, dividends and share-price gains. To generate that return, you might have perhaps 50% in stocks and 50% in bonds. Every year, to get your 4% portfolio withdrawal, you could spend your dividends and interest, while also cashing in some of your stock market and bond market winners. What if you don’t have any winners to sell because you just got hit with a big market decline? As a precaution, consider rigging up a robust financial safety net.
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