Generating a 6% Income for Retirement

Defensive Investing, Dividend Growth, Dividend Investing, Retirement

Find out how you can easily set up your income portfolio so that you will never run out of money in retirement. Using high-yield stocks and a specific reinvest and withdrawl combination, you can watch your nest-egg and income grow every year. 

The financial advisor community faces a big dilemma when advising their clients about how much income their savings can generate in retirement. With interest rates remaining low and a volatile stock market that looks like it will have trouble matching past results, the old “draw 4% each year” rule has a high probability of draining a retiree’s accounts well before the end of their life. For example, a recent article by Wade Pfau, Ph.D., CFA was titled “39 Modern Retirement Income Planning Techniques”.

Yes, 39 different possible strategies!

While I am not a retirement planning expert, I know a few things: Probabilities only work for large numbers and individual results can and will vary significantly from large group percentages. As a result, any individual retirement spending plan from a probability-based system will most likely end up much different than the original plan.

39 different strategies put out by a lot of smart people means that a really good solution is very difficult to find. The safe end of the spectrum will result in very low withdrawal rates, not providing enough income to live on. More aggressive strategies could lead to an exhaustion of retirement funds at a time when they may be needed the most. As a contrast to PhD developed, complicated systems, I prefer the simplest approach to get the job done.

With an average yield of 7.5%, my recommended stocks list can allow you to set up a 6% withdrawal strategy that will not result in the depletion of capital or the chance that you run out of money in your later years. Just because the basic strategy may be simple, the execution will likely be more complicated.

Here’s how it works.

What follows is an illustration of the strategy using a hypothetical example, your results will probably vary.

Let’s start with $400,000 in retirement plan assets as an example.

This is the money that will be used to produce a portion of your retirement income. In addition, you should have other money set aside as an emergency fund. Six percent of $400,000 is $24,000 or $2,000 a month of retirement income out of this starting nest egg. With our income goal set, here is how we set up the retirement income system.

Three months’ worth of income or $6,000 is set aside in cash. Since all of the stocks in my Divided Hunter service stocks pay at least quarterly, in a three month period your brokerage account will collect a full cycle of dividends. (Note: you’ll want to consider adding quality monthly paying dividend stocks too.) The remainder, $394,000 is evenly invested into the rest of your dividend and income portfolio.

Remember that the stocks on my list have a current average yield of 7.5% so I’ll use that as our baseline example; again, your average will probably be different depending on which stocks you add to your personal portfolio.

In the first three-month period, $6,000 will be withdrawn in the form of $2,000 per month income checks. The $394,000 in stocks will generate dividend earnings of $7,387.50.

If we continue to draw $2,000 each month for a year, and let the portfolio earn $7,387.50 in dividends each quarter, at the end of 12 months, the cash in the account will be $11,550.

It’s time for a raise! For the second year, let’s increase the monthly income by 2% to $2,040. We set aside $6,120 to cover the monthly checks for the next quarter, which leaves $5,430 that we will use to buy more shares of the holdings in our income stock portfolio.

Using the false assumption that share prices have not changed over the course of the year, with the added investment our stock portfolio is now hypothetically worth $399,430. With more shares in the account, we will be earning more in cash dividends.

After drawing $2,040 in monthly checks in the second year, and retaining dividend payments, by the end of the year the cash balance is up to $11,597.25. Another 2% raise gives us a monthly check of $2,081 in year three and after setting aside three months of retirement income, we will have about $5,354.25 in excess cash to reinvest. Each year this pattern will repeat.

Our static example here shows that with a portfolio dividend yield of 7.5% and a disciplined withdrawal of 6% per year produces an income stream, dividend stream, and portfolio value that all grow by about 2% per year. I like that plan better than some of the mainstream investment and withdrawal strategies where you draw just 4% per year and run out of money after 30 years.

Of course, you are aware that we don’t live in a static stock market world, so here are some of the factors that we need to be aware of and possibly would require adjustments to our retirement income plan.

Many of the stocks increase their quarterly dividend rates over time, so your dividend portfolio will actually generate more cash, leaving more excess cash flow which can be reinvested.

You don’t need to wait until the end of a year to buy more shares. If the market drops and there is excess cash above the near-term income needs, it could be a good time to buy cheap and boost the portfolio’s cash flow yield. Selling a stock and buying another will change the projected dividend income to either a slightly higher or slightly lower amount.

It is possible that one or more of our portfolio stocks will reduce or eliminate its dividend payments. This is the biggest risk of this strategy. And it is probable that no matter how much we research and try to stick with the safest dividend stocks, there will be the occasional dividend rate reduction.

You might have noticed that there is no discussion about share prices. That is because this dividend-centric strategy allows us to hit the retirement income goals in both up and down markets.

If share prices fall, you buy more shares at lower prices and boost the portfolio dividend cash flow yield.

If share prices rise, the dividend income will not grow as fast, but you will get those good feelings from looking at a bigger brokerage account value and can congratulate yourself on being a brilliant investor. It’s a win-win in all market conditions, and YOU DON’T WORRY ABOUT THE DIRECTION OF SHARE VALUES!

The core of making this strategy work is to own a diversified portfolio of dividend stocks that generate an average yield greater than the withdrawal rate. These stocks must have secure dividend payments and offer the potential for, on average, modest dividend growth.

In my newsletter, The Dividend Hunter, I make it a habit of only hunting down and recommending the most stable companies that regularly increase their dividends, and this is the strategy that I use most often to produce superior results, no matter if the market moves up or down in the shorter term. The combination of a high yield and regular dividend growth is what has given me the most consistent gains out of any strategy that I have tried over my decades-long investing career.

And, there are currently over 20 of these stocks to choose from in my Monthly Paycheck Dividend Calendar, an income system used by thousands of dividend investors enjoying a steady stream of cash.

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