There are essentially four main ways people can get paid when they are retired. From my observations in helping others, the most common to least common of these ways are:

  1. Social Security – don’t bank on this as a good source of growing income!
  2. Income from investments (IRA, 401k, etc.)
  3. Working a part time job, if you can.
  4. Pension

Let’s say you have a cow or a herd of cows. You can derive income by either milking a cow or killing the cow for meat. One is rather final. The cow can no longer produce milk if you butcher it. I prefer to milk the cow. This is the income school of thought.

Your investment portfolio needs to pay you during retirement.  If it doesn’t, then why have it?

According to Ben Reynolds of Sure Dividend, there are two schools of thought regarding how your portfolio should generate retirement income. The two are:

  • The liquidation school: You don’t think about income. You sell a portion of your investments and take that as income.
  • The income school: Your portfolio pays you interest and dividends

If you belong to the liquidation school, you have the potential to get a little nervous if a bull market has run a long time or you get very nervous if the market goes down dramatically in a “market correction” or a bear market. If you belong to the income school, and you have done a good job, you don’t have to sell during down markets. You can continue to collect dividends and interest. The risk is that dividends will be reduced, but that is generally unlikely. Companies don’t like to do that. You can mitigate that risk by paying close attention to the dividend payout ratio. In other words, you ask the question, “do earnings easily support the dividend?”

Imagine the market corrects down or crashes.  Both portfolios could be down 35%.  In the income portfolio, you don’t have to sell.  Just because the portfolio value is down, that doesn’t mean your income is down.  But that isn’t the case with the portfolio that focused on growth of the investment.  If you need $40,000/year and your portfolio started at $1,000,000 in value, then you have a portfolio that is worth $650,000. That means you must sell a greater percentage of your holdings to get $40,000 in income. To increase the pain, that also means you are selling when you should be buying more!

.“Simply put, market volatility affects stock prices, not dividends.” Ben Reynolds, Sure Dividend

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