by Let me share with you a story that may shed some light on fixed-income retirement portfolios.
The main characters of my story are a couple in their 70’s—let’s call them Bob and Sue—who came to me concerned that their cash flow wasn’t what it used to be. The following is our conversation:
Bob began speaking: Jaimie, we can’t understand what’s happening to our cash flow. When we retired 15 years ago, we seemed to have plenty of money. We were able to take 2 or 3 really wonderful trips a year, we contributed funds for our grandchildren, and wrote monthly checks to charities that we cared deeply about. We just never had to worry.
Sue interrupted: I especially liked giving to charity. It makes me feel so complete.
Bob: Now it’s another story. It seems like each month I’m taking more and more out of my portfolio just to keep up. We’re afraid we are going to run out of money. Can you help us?
Jaimie: I’ll do my best. Tell me about your portfolio.
Bob: My parents lost all their money during the great depression. So we decide to keep most of our money in bonds. I figured that was the best way to create the income we needed for our retirement. We have a true fixed income portfolio.
Sue: I would have preferred some stocks. I thought it would be a growth opportunity for our grandchildren’s account, but Bob was really afraid.
Jaimie: Is it important for you to have enough cash flow to continue your current lifestyle.
Bob & Sue: Yes.
Jaimie: Do you want to become a financial burden to your children?
Bob & Sue: No.
Jaimie: Let me ask you a question? How much was a first class stamp in 1980?
Bob and Sue scratched their heads.
Jaimie: Would you be surprised if I told you it was 15 cents? So in a world, where a first class stamp more than triples in 34 years to 49 cents, what happens if your income is fixed, but your cost of living keeps increasing?
Bob: We would have to continue dipping into principal to cover the short fall.
Jaimie: What’s the potential risk of dipping into principal?
Bob: Running out of money.
Jaimie: The need to design a retirement portfolio as a Fixed Income Portfolio is essentially a myth. Let me explain…
Here’s how Harold Evensky, author of Wealth Management describes fixed income portfolios.
It is a myth that investors must construct portfolios that generate dividends and interest (ie., not touch principal) in order to receive cash flow. An income portfolio that is “fixed” by design— is inappropriate design. An income policy enforces an inappropriate constraint on portfolio design that, in almost all cases, will result in an inferior portfolio. In many instances, it will lead to the design of a portfolio that is not only inefficient, but one that will not allow the client to accomplish his or her goals.
Lesson for Bob & Sue— When constructing your retirement portfolio, don’t be seduced into thinking fixed income. Think TOTAL RETURN. Your children will be happy you did.