Strategies for Income and Wealth Replacement

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By Maurice Stouse

Financial Advisor and Branch Manager

Maurice Stouse

These days many investors are in search of income. With interest rates nearing record lows, a recent sell off in the stock market, job losses, early retirements, reduced or eliminated dividends, income security has become even more important to many Americans. Equally important is principal security. Investors, savers and those in need of income have quite the dilemma: How to get income security yet not have to sacrifice principal in order to do so. This article explores ideas for investors to consider. Ultimately each person’s situation is unique so this is a guideline to aid you in your research and decision making.

The yield on CDs, Treasury bonds, money market funds and savings accounts took a sharp downturn this year as the Federal Reserve worked to bring liquidity into the economy in the face of the COVID 19 virus and the disruption it caused. This meant reduced interest rates on many investments that a lot of individuals relied upon for income or, as a supplemental to Social Security, pension or other income. The problem many have faced is that it takes more principal to fund the same income. Or it means the systematic liquidation of assets to meet a given income need.

Enter solution one: The systematic withdrawal plan (SWP or swip). This is how it works. Here is where you start with inputting a desired income amount. Next you would add the amount of principal you can afford to apply to that income. You will also need to put in the percentage you need to earn to meet the income, add any rate for presumed inflation and lastly put in a projected or expected rate of return. There are many tools available online and through Financial Advisors that will assist you on building this scenario.

Here is an example. Let’s say a 72 year old retiree with one million dollars in her account desires annual withdrawals of $40,000 per her required minimum withdrawal. She is concerned about the systematic liquidating of the investment and she does not know how long she will need to rely upon it, or in other words, how long she will live. Also, she may be concerned if her income will keep up with the cost of living. Using the calculator and inputting the 40k, she will find that the account has a withdrawal rate of just over 4% per year. She also instructs the calculator to assume her investment will return 5%. Inflation is factored in at 2%. The results show (if all assumptions turn into reality) she will receive the annual income of $40,000 and if she were to attain age 100 (28 years later) her account would then be worth $1,014,656, about where she started.

Next, solution number two: Income investors might also have the concern that they do not want or cannot commit all of their capital to one strategy. They may need to have funds set aside for an emergency or other needs as well. Insurance companies offer a variety of options through the use of annuities that might involve investing less principal and, given the needed investment performance, might even grow the income. This strategy might also free up capital to invest for long term growth (and not have to have it focused on current income) in an attempt to replace the wealth that was being utilized to provide the income.

There are more aggressive strategies, such as a dividend producing stock portfolio where the income would come from the dividends paid by a basket of stocks or by using a stock mutual fund. The average yield on the S&P 500 is just below 2% so an investor needing 4% would need to research companies and or mutual funds (or exchange traded funds) that would have that return. There is also the growth (or loss) potential on the stocks.

Finally, many income investors have turned to real estate over the years for long term income.  Some have done so by way of investing in rental properties and others through Real Estate Investment Trusts (REITS) to generate the income and perhaps the wealth replacement they have as a goal. REITS invest in to a number of properties and the investor can buy the REITS themselves or funds made up of REITS. Once again capital appreciation is a potential but so is the potential for loss.

When considering any of these options it is important to take note of 1) the risks involved to your principal 2) the risk of sustaining a given rate of return (for example a company may decide to reduce or eliminate a dividend) and  3) the costs associated through the strategy (expenses, maintenance (real estate) riders if any, early withdrawal charges if any, investment expenses).

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