Throughout many conversations I have had with some of you following my recent newsletter offering, I thought I would address a very interesting point that came from one of your main concerns. In that newsletter, I was discussing various investing issues and asking my readers what their main concern was. I asked you this question because I am finishing the final lines of my 2nd dividend eBook and wanted to make sure I’ve covered everything. One of the recurring issues was everything around managing a dividend portfolio at retirement.
There are a lot of things that change when you retire
The first change you experience when you retire is psychological. If you don’t have a pension plan and rely mostly on your portfolio to live the good life, chances are that you will become anxious about any fluctuations in your investments. This change in perception may push you to make irrational trades or move towards the safest investments (such as bonds and CDs). If you have a lot of money and don’t need an investment return to retire, it’s not the end of the world. However, chances are that you probably need an investment return of 4-5% to avoid being forced into a Wal-Mart greeter position for the rest of your life.
The second important change upon retirement is the fact that you not only need to have an investment strategy but you also need a withdrawal strategy. Withdrawals are very important as you must calculate tax implications; costs incurred along with time required (are you going to assess your portfolio quarterly to know what you will be selling in order to live?).
Deal with the Psychological Impact
There is not much to do to convince yourself that fluctuations are normal if you are freaking out every time that you lose 4% on paper (besides a few meetings with a psychologist, hahaha!). But I think that there is something you must do: have a retirement plan done by a planner. With a complete retirement plan, you will be able to know how much investment return your portfolio must generate to support your lifestyle until you pass away (around the age of 90 or so).
After revising your plan, if you don’t need more than a 2-3% yield (just to protect yourself against inflation), then you could move almost your entire portfolio towards bonds and forget about any risk. Unfortunately, the reality will probably different for 80% of you: most will need a 4-5% investment return to support your lifestyle.
If you are part of the 2nd group (those who need some investment return to retire peacefully), chances are that you will need to stick with a dividend portfolio. But instead of taking a few risks here and there while managing your money, I’d suggest you become very strict in the choice of your holdings. Therefore, I would tighten the rules in order to own only the most solid dividend payers. This could include:
Minimum dividend yield: 2.5% and higher (to include some strong dividend payers under 3%)
Payout ratio: under 50% (to assure dividend growth)
Revenue and Profit growth over 5 years: positive
With very strict metrics, you will be able to build a solid and stable portfolio that won’t be affected by market fluctuations too much.
Have a Withdrawal Strategy
Playing around with your investment strategy while refraining from making emotional trades is the easy part. The hardest part is to setup a withdrawal strategy that will ensure a maximum benefit with minimum transactions. Unless you are super lucky and can simply live off your dividend payouts, you will have to withdraw a part of your capital every month.
The first question is “where do I get my money first?” The answer is quite simple: from your non-registered accounts. Since everything is taxable within these accounts, you must empty them before you take money from your registered accounts (RRSP & TFSA for Canadians, 401k and Roth IRA for US residents).
Then, the second question is “how do I withdraw my money?” Once you have taken your dividend payouts, where do you get the rest of your money? Do you sell a big chunk at the beginning of the year and use this money throughout the year? Do you sell shares every month to compensate?
The last 2 options are pretty costly. The first one will prevent you from earning dividends and capital gains and the latter will generate a lot of transaction fees. I’m in favor of another alternative: sell what you need at the beginning of the year and invest it in dividend or mortgage funds that will enable free monthly withdrawals. The money will be invested in the market while you don’t need it and you can receive your “monthly pay check” in your bank account automatically.
I suggest either a dividend or mortgage fund because it depends on how “aggressive” you are on the market. If you don’t want to bother too much with market fluctuations, the mortgage fund will do the job well. The dividend fund is useful if you want to benefit from the full potential of your money as it will be invested in stocks similar to those in your portfolio.
In my book, I’ll be offering real examples of portfolios that can be built for retirement. If you have specific questions, please leave me a comment!