Retiring stress-free sounds like a dream for most, especially since interest rates remain at historic lows. Some have already forgotten that the best plan for retirement used to be this: live off of income generated by bonds. That plan has gone out the window for most since the income for treasury bonds does not even cover inflation any longer.
So why is living off income in retirement so important? Imagine an hourglass that you turn over and watch the sand slowly dwindle away. It's a similar situation to dipping into your investment principal in retirement. It is only a matter of time until the money is all gone.
It Is Becoming More Difficult To Generate Enough Retirement Income
Some people believe that low interest rates are a temporary measure, but are they really? There is one country that comes to mind where interest rates have remained extremely low (lower than the U.S.) for over 25 years now. I'm talking about Japan.
If our central bank (the Federal Reserve) is intent on keeping interest rates low for a long time, we must look elsewhere for income in retirement. Bonds just will not cut it.
Using Dividend-Growth Stocks
Unfortunately, many people have attempted to generate income using annuities. This is a mistake for most. The vast majority of annuities have hidden fees and surrender charges. They can also severely limit your investment choices.
The best choice today for income in retirement is dividend-growth stocks. I have written previously about how dividend-growth stocks can help people retire early. I now want to take a look at how we can use dividend-growth stocks to generate enough income in retirement such that we never need to dip into investment principal.
When looking for great dividend-paying stocks, I start by analyzing companies who consistently increase their dividends over time. We can find these in the Dividend Aristocrats list.
Dividend Aristocrats are some of the best-run businesses out there. To be a dividend aristocrat, your dividends must have increased by 25 or more years in a row.
A Case Study
Let's consider the case of a couple that is trying to make it on treasury bonds. I created a retirement plan using the WealthTrace Planning Software, and have made it publicly available with a free trial.
The couple I want to look at today are currently 55 years old and their desired retirement age is 65. They have $45,000 combined in social security and they plan on spending $55,000 per year in retirement.
In my first pass at their plan, I assumed they have invested 100% in treasuries when they retire. They also have $800,000 saved when they retire.
In the following chart you can see that eventually their income in retirement will not cover their expenses. The hourglass starts to drain for them.
We also project that their money will dwindle to zero by the time they reach the age of 88.
The Solution: Use Dividend-Growth Stocks
What if we instead take half of their money and move it into dividend-growth stocks? A few of my favorite dividend payers for retirement are Exxon (NYSE: XOM), Altria (NYSE: MO), Johnson & Johnson (NYSE: JNJ), and Procter & Gamble (NYSE: PG).
Note that I do not recommend that people put their money in just a handful of dividend-growth stocks. It is important to diversify among several companies like the ones I've mentioned.
Back to the new strategy. My assumptions for the dividend payers are this: a dividend yield that averages 3.5% for the dividend payers, average dividend growth of 7%, and stock price gains of 3% per year.
Now this couple is in much better shape. Notice how their income in retirement will cover expenses in each year. This means that they do not need to dip into the principal of their investments. This is the stress-free position we were looking for.
Generating enough income in retirement is not as simple as it once was. We need to dig deep into good dividend payers and select those who have never cut their dividends and, even better, have increased their dividend payments consistently through time. In today's world this is the best way to retire stress free.
Let the free MoneyTips Retirement Planner help you calculate when you can retire
without jeopardizing your lifestyle.