To plan for retirement income and needs, many use the 4% rule, which refers to selling 4% of your portfolio annually to cover living expenses post-retirement. There are several practical issues with implementing this rule, such as the impact of inflation and the unpredictability of market cycles. In addition, selling the principal of a retirement portfolio causes mental stress and the longer you live, the higher the stress.
A better alternative is to construct your retirement portfolio to generate income, without selling down the principal. If 4% is what you need, you can invest in shares of high-quality, dividend-paying companies that generate, on aggregate, 4%-5%[1] income, and maintain or even grow the income and principal of the portfolio over the long term. The dividends will also be qualified for the lower capital gains rates (0%, 15%, or 20%) after an initial 60-day holding period.
The table below is an example of how this can be done in the current market environment. This is a portfolio of 30 publicly listed equities, well diversified across industries, currently yielding 4.6%. These are carefully selected names based on strong business fundamentals and management teams. Any short-term price declines can provide opportunities for reinvesting excess income to generate a higher portfolio yield. Over the long term, many names in the portfolio have the potential to grow both income and principal.
| % of portfolio | dividend yield | Portfolio Income | |
| BDC(6 names) | 25.0% | 9.00% | 2.30% |
| Energy MLPs(2 names) | 7.5% | 6.50% | 0.50% |
| Energy (2 names) | 7.5% | 4.00% | 0.30% |
| REITs( 4 names) | 15.0% | 5.00% | 0.80% |
| consumer staples (8 names) | 25.0% | 2.50% | 0.60% |
| Other -tech, media, financial services(7 names) | 20.0% | 0.90% | 0.20% |
| 100% | 4.60% |
In general, depending on a retiree’s portfolio size and living expense needs, one can construct portfolios with different weightings of high-quality dividend-paying securities and generate the needed amount of income, with different expectations of dividend and principal growth. The longevity of your portfolio can grow together with the longevity of your life when this approach is applied with careful research.
[1] To ensure after-tax income is 4%. Tax rates for qualified dividends vary from 0% to 20%.