The search of income in retirement

Imagine you’ve just retired with a nest egg of one million dollars. You’re trying to decide how to invest that money to create an income that will sustain you for the next 30 years.

I’ll ask you to choose between a diversified portfolio of AAA-rated corporate bonds yielding nearly 12% and an equally diversified portfolio of common stocks paying less than 6% a year in dividends. You already understand that when it comes to bonds, both your income payments and principal are backed by some of the highest-quality companies around. That’s not the case with common stocks, where nothing is guaranteed.

Sounds like a no-brainer, doesn’t it? Do you choose a relatively stable investment that pays you an income of nearly $12,000 a year, or the volatile one that pays less than half as much? Stocks for growth and bonds for income, remember? And as a retiree, you need that income to live on.

Think twice before you answer.

The example above is anything but hypothetical. At the beginning of 1982, AAA-rated corporate bonds were yielding 11.8%. The dividend yield on the S&P 500 was 5.7% – less than half of what high-quality bonds were paying at the time. Yet over the ensuing 30 years, an investor would have received about $3.8 million in dividends from owning stocks, versus about $3.5 million from bonds.

And let’s not even dwell on the fact that while the bond investor received his entire $1 million of principal back at the end of the 30 years, the stock investor’s portfolio would be worth nearly $11 million – even after spending all those dividends.

Does it always turn out this way? No. I’ve looked at every 30-year period from 1919-1948 to 1993-2022 – that’s 75 hypothetical “retirements” in all – and stocks paid more income than bonds in 60 of them, or 80% of the time. And at the end of each and every 30-year period, the stock portfolio was worth much more than the bond portfolio – about seven times as much on average.

Why did these things happen? Two reasons. First, while bonds sometimes pay an attractive yield, that income is typically fixed for the life of the bond, which is why bonds are referred to as fixed-income investments. Stock dividends, on the other hand, are not fixed. In fact, since 1919, dividends have actually declined about one year in every four. Over that same period, however, dividends have increased by an average of more than 6% a year.

And second, while fixed-income investors like knowing they’ll likely get their principal back at maturity, stock investors are willing to accept a lot of day-to-day uncertainty in exchange for the potential for better long-term returns. Most investors understand that stocks have had higher returns than bonds over long time periods; the fact that they’ve also returned more income in the process is what surprises most people.

Yet even with that track record, I would never recommend a new retiree put everything in stocks instead of bonds. You don’t have to make that choice: you can and probably should own some of both. But if you expect your expenses to increase over the rest of your retirement – and they almost certainly will – then owning a portfolio whose income is virtually certain not to increase is a mistake you cannot afford to make.

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(Data source: Robert Shiller, Yale University Online Data - Robert Shiller (yale.edu))

Any opinions are those of Brown Family Wealth Advisors and not necessarily those of Raymond James. This material is being provided for informational purposes only and is not a complete description, nor is it a recommendation. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Dividends are not guaranteed and must be authorized by the company’s board of directors. No investment strategy can guarantee your objectives will be met. Past performance is no guarantee of future results. Prior to making an investment decision, please consult with your financial advisor about your individual situation.