Why Should I Diversify My Retirement Income?
by: Michael Snowdon, CFP
Retirement is often viewed with great anticipation. This is especially true for people who have retirement income guaranteed by an employer-provided pension plan. It is reassuring to go into this new period of life with the assurance that income needs will be covered. Unfortunately, many people who depend on the fixed income payments from a pension, annuity, or other sources may develop concerns several years into retirement for many reasons. as they are at the beginning.
Although a fixed income amount may be adequate at the beginning of retirement, inflation will make it less so after several years. If retirees experience historically average inflation of 3.0%, in 24 years twice as much money will be needed to cover income needs versus what was required at the beginning of retirement. For example, in 24 years today’s $2 loaf of bread with become $4 and a $4 gallon of milk will rise to $8. While monthly income remains the same, inflation steadily erodes its purchasing power.
The Importance of Variable Income and Investments
Adding an income stream that is not static solves the problem of inflation. Rather than remaining the same over time, a variable income stream can increase as inflation increases. While there is no guarantee income streams will increase in lockstep with inflation, it is likely they will at least keep pace, if not exceed inflation’s impact.
Most pension plan and fixed annuity retirement income payments do not increase with inflation. It is a wise approach to add an income stream that does increase. The best way to do this is to save and invest money in a stock-based account. Stocks (or equities) may seem an unstable investment as value regularly moves up and down, but historically, stock-based investments increase over time and have been shown to keep pace with inflation. Allowing enough time is important as short-term results (over only a few years) may be disappointing. When the timeframe is expanded to six or seven years or more, the impact of stock investment variability and volatility generally decreases. The resulting investment returns generally move in an upward direction. This is exactly what someone wants whose retirement income must increase to keep pace with inflation. There are no guarantees that stock-based investments will continue to increase, but for the last 100 years, this has been the case.
How can someone put money into a variable investment?
Mutual funds, exchange-traded funds and variable annuities all are reasonable options for variable investments. Many of these are available in IRAs, 401(k) and 403(b) accounts and provide tax-deferred growth.
There may be concern over giving up a guaranteed, stable income base – but there is no need to do that. Instead of eliminating pension or other fixed-income payments, supplement them with a variable income stream. Combining both can provide a solution to the need for a stable fixed income along with a variable income stream to counteract the erosive effect of inflation. This can result in a more comfortable retirement over many years.
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