Ultimately, you should be able to replenish your bond ladder by selling some appreciated stocks to buy six-year bonds, five-year bonds, etc. Image: BoxerX/Shutterstock.com
By: FEDweek StaffBefore you retire, you need to anticipate how much of your portfolio you’ll withdraw. If you expect to take out 7 percent or more each year, you’re likely to have a portfolio skewed towards equities and run into trouble when the stock market turns down. Generally, you shouldn’t be withdrawing more than 4 percent of your portfolio when you first retire.
With a $500,000 portfolio, for example, you might plan to withdraw $20,000 (4 percent) per year. Once you have that type of a plan, you can develop a strategy for having that cash available. You might construct a bond ladder, for example, with maturities every year.
That is, you might hold $20,000 worth of bonds set to mature in Year One of your retirement, another $20,000 in bonds to mature in Year Two, and so on, through five or six years of retirement. You should use individual bonds or bank CDs, rather than bond funds, in order to receive a certain payback at maturity.
Each year, then, you’ll be able to use the proceeds from the maturing bonds for spending money. This strategy will permit the balance of your portfolio to remain intact, and the longer your stocks stay in place, the greater the chances for superior returns. Ultimately, you should be able to replenish your bond ladder by selling some appreciated stocks to buy six-year bonds, five-year bonds, etc.
However, in order to implement this strategy you need to have your bond ladder in place as you go into retirement. Therefore, you should set up your portfolio in your pre-retirement years. Make sure you’re holding some cash, some bonds that will mature at regular intervals, and some stocks that can provide the growth you’ll need for a long, comfortable retirement.
Alternatives to bonds and a bond ladder include:
Bond Funds and ETFs. Instead of holding individual bonds, investors can opt for bond mutual funds or exchange-traded funds (ETFs). These funds pool money from multiple investors to purchase a diversified portfolio of bonds, providing professional management and instant diversification. Bond ETFs, in particular, offer the additional benefit of being traded like stocks, albeit with variable yields and fluctuations in price.
Dividend stocks. For those seeking income, dividend-paying stocks are an attractive option, especially blue chip companies and “dividend aristocrats” which have a long track record of if not increasing, not cutting their dividends. They have the upside of capital appreciation. Again, be prepared for a loss of principal when holding equities – these are not bonds, but some companies such as utilities are often utilized this way.
Real Estate Investment Trusts (REITs). REITs allow individuals to invest in commercial real estate properties without owning physical real estate. As these trusts generate rental income and often pay high dividends, they can serve as a supplemental income source while diversifying one’s portfolio beyond traditional bonds. The REIT structure actually requires the company to pay out some 90% of taxable income in the form of dividends.
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