How Will You Generate Retirement Income?

Retirement income is a primary consideration when planning for your later years. After all, your level of financial freedom, flexibility and comfort will largely be determined the how much retirement income you can take. Investors who neglect to save enough for retirement could face difficult decisions later in life if they aren’t able to afford their desired retirement lifestyle.

Some workers are able to contribute to a pension of some sort that can help fund their retirement. However, retirement investors may also need to explore other methods of generating income in retirement in case your pension isn’t sufficient. Another potential source of retirement income to explore is investment income. Investment income or cash flow can come in many different forms, such as stock dividends, fixed-interest payments, proceeds from selling shares and more.

When thinking about your retirement goals, you may wonder how your assets and savings today will benefit you in the future. Financial advice can be extremely helpful for current retirees as well as for workers building towards retirement. Along with saving early and consistently, a diversified investment portfolio can help provide long-term portfolio growth and, when needed, retirement income. 

So, how is retirement income generated and how do you balance income against growth?

Differentiating Income from Cash Flow

Some investors may believe investment income and cash flow are more or less the same thing, but we think there is an important difference: income is money received, whereas cash flow is money withdrawn from an account. For example, dividends and fixed-interest coupon payments are income, while cash proceeds from selling a security or other investment is considered cash flow. The difference between the value of your initial security purchase and the value of the security when you sell it is called a capital gain (or loss).

It can be a good thing to withdraw cash flow from your portfolio if this is part of your overall income-generation or tax-planning strategy. However, too many unplanned withdrawals can eat into the overall value of your investments. If your withdrawals begin drawing down your account too soon, you may even need to alter your future cash flow expectations.

Understanding and planning for your desired level of retirement income or cash flow—whether the funds come from a pension or from selling investments—should be an integral part of your financial planning and is something you need to discuss with your adviser. Your adviser should be able to help you estimate how much you may need to save now and how much growth you may need in order to meet your long-term goals.

Fixed Interest—By No Means Risk-Free

Although it can be tempting, investing solely in income-producing investment products—such as fixed-interest securities or high-dividend equities—may not be the best approach to generating retirement income.

The lower short-term volatility of fixed interest securities compared to equities may make fixed interest investments seem safer or more prudent. Similarly, fixed interest yields are often predictable and consistent. However, lower short-term volatility often entails lower long-term growth potential, which can be harmful given your portfolio may need to outpace the rate of inflation and more. If you require long-term portfolio growth in or for retirement, investing solely in fixed interest investments may not provide sufficient long-term returns to meet your goals. 

Furthermore, investors face many different risks depending on their strategy and goals. Just because fixed income is not subject to the same short-term volatility as equities does not mean that it is risk free. Rather, fixed interest as an asset class has its own set of potential risks, including:

  • Default risk: Bonds carry a risk that the bond issuer—usually a company or government—cannot pay interest or fails to repay the amount invested.
  • Interest rate risk: Bond prices have an inverse relationship with interest rates, meaning they move in opposite directions. When interest rates rise, investors’ bond values may fall. So investors needing to sell their bonds before maturity might have to accept a lower price.
  • Reinvestment risk: There is a risk that when bonds expire and money is returned, it is not possible to reinvest at a similar level of risk- and return- expectation, thereby causing you to deviate from your original retirement plan.

When retirement planning, it will pay to consider your assets and options to build a retirement portfolio that will offer the income and benefits that will suit you best when you retire. You should always keep your long-term financial goals top of mind when considering how to invest.

Dividends

Dividends can seem very attractive: getting paid to simply hold equities sounds like a winning situation for the investor. But below the surface the benefits are less clear.

For a start, certain equity classes and shares may enjoy periods when they do well and other periods when they do not. If a company does not do well, a company may reduce their dividend or cut it altogether. Also, dividend paying companies’ stock prices may fall by about the amount of the dividends being paid. If that happens to your stock, it’s not quite the “free money” you may have thought it was.

Also, portfolios consisting solely of high-dividend equities may have holdings in just a few market sectors with assets that behave similarly to each other. This can leave you with potential diversification issues. If those sectors or countries perform poorly, your portfolio may face increased volatility or underperformance—potentially reducing your chances of meeting your long-term goals.

This is not to say that dividends are bad news. Instead, it is better to evaluate a portfolio based on total after-tax return rather than the method of income generation. Depending on your situation, investing solely in high-dividend equities may not be the best way to achieve your long-term financial goals. Simply put, you may be better off diversifying and investing in securities and funds that align with your broader retirement plan. 

Income-Generating Insurance Products

In some countries, life insurance products may be available to provide monthly or ongoing income for retirement. In many of these cases, investors can purchase an insurance product—that may invest funds for them—and receive lifetime payments based either on the performance of the underlying assets or a predetermined (fixed) rate. While these payments may sound nice, insurance products can be complex at times.

Before you commit to any insurance products, it is essential that you fully understand the terms and conditions, including fees and any potential drawbacks. While these products may not seem risky at first glance, they not be the best way to limit the risk of losing money.

Fisher Investments UK Can Help

As an investor, it’s crucial to focus on your portfolio’s total return and to balance retirement income against long-term growth in a way that is right for you. Goal-focused investing should prioritise diversification and maintain discipline so that your investment strategy serves your long-term financial objectives.

At Fisher Investments UK, we can help you better understand your long-term financial goals and how long you may need your money to last. Only when you have these things in mind can you effectively decide how much money you will need in retirement and whether any pension income will be enough to cover living expenses when you retire.

Call us today at 0800 144 4731 to speak with one of our professionals, or download our Definitive Guide to Retirement Income to learn more. All our financial and investment guides are free, educational and offer useful suggestions to help you invest and plan for the long term with confidence.

Investing in equity markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world equity markets and international currency exchange rates.