Retirement Income

Investing in a low-interest rate environment

You have done a great job saving and building your nest egg for retirement, the problem is the day you retire interest rates are at an all-time low. We see this dilemma on a daily basis. Many of our clients who are retired and ones that are getting ready to retire need to create an income stream. This used to be an easy problem to fix when the 30-year treasury was at 6% and you could buy safe, fixed-income investments that created a decent income stream. What do we do now?

The dynamics of the market have changed. The risky investment is now owning the longer duration bond and the less risky investment is owning the “Blue Chip” stock that pays a good dividend. It’s the opposite of what every financial book has taught us. Bonds are less risky than stocks. Wrong, bonds are now the more risky asset class. Why? Rates are so low that the fixed income investment has two major flaws. First, you cannot keep up with inflation owning bonds, thus you are losing buying power and essentially principal. Second, when rates go up, the value of your principal is going to decrease and possibly decrease by a significant margin.

You are probably thinking “How can this work? I am retired and I need to own stocks. Isn’t that risky?” It can be very risky if not done properly through a selective screening process. We need to select each stock based on very specific criteria which allow for the growth of dividends. The company’s dividend growth rate is a very key element in our stock selection. There are companies that increase their dividend on regular basis, and we do screens on regular basis to find them. The companies that continue to increase their dividend over time will be less risky than ones that do not. This makes the stock not only less volatile, but also more predictable for future income stream. This will allow you to derive more income and potentially more principal over time. There will obviously be fluctuation in principal along the way, but we foresee this to be less volatile than owning long duration fixed income securities.

For example, let’s assume you have a $500,000 portfolio of “Blue Chip” stocks that pay a dividend rate of 3.5% annually. The dividend income you generate will be $17,500, and most if not all these dividends will be qualified and only taxed at the 15% rate unless you fall in the 39.6% tax bracket, those will be taxed at 20%. Let’s also assume the dividend growth rate for the companies in your portfolio is 5%. The fifth year of owning this portfolio will provide you with a dividend income of $22,334 annually. This solves a couple of the problems stated previously in the article. The first problem solved is that dividend outperforms inflation at current levels of around 2%. The second problem solved is that your portfolio becomes less interest rate sensitive. This strategy will help you sustain until rates go back up and you can purchase fixed-income securities with less risk and higher income streams.

The bottom line is that retiring when rates are low makes investing for income a little more tricky. Do your research or hire a professional to help you. All the opinions expressed within this are that of the author and should not be considered advice for your individual portfolio. All investors have unique situations, and your portfolio should be tailored to fit your needs and risk tolerance. If you have any questions on this topic, call me at 772 223-9686. Fogel Capital is a federally recognized Registered Investment Advisory firm with over a quarter of a billion dollars under management located in Stuart, FL.