I recently read an interesting CNN article that focused on the concept of "pre-tirement," which is essentially the practice of engaging in retirement activities like travel and self-improvement continuing education classes, while one is still gainfully employed. The premise of the article was the following reader question:
I recently heard about a new way to look at retirement that involves staying on the job but stopping your retirement account contributions so you can use them to fund a "practice" retirement while you continue to work. The concept seems appealing. Can you tell me more about it? -- Paul Morgan, Brookhaven, Miss.
While I didn't agree with a lot of the advice presented in the article, it was nonetheless a stimulating read—and one that got me thinking about portfolios and retirement investing strategies.
Pretirement, My Way
I think pretending to be in retirement might actually be a great exercise for investors starting to think about retirement. Here's how I'd envision it working. Pretend for a moment that you've just retired. Now roughly add up all your sources of income for the year—Social Security, pensions, dividend/bond/REIT income, and any capital withdrawals you plan to engage in.
Once you've arrived at this number, use it as a "spending cap." Divide it by 12. Each month, you're only allowed to spend 1/12th of your total "retirement income." (Allowable exceptions include things that will go away in retirement, such as 401(k) or IRA contributions, and if applicable, mortgage payments on your house.)
Can you do it? If the answer is "no," you need to reevaluate your portfolio, or else you'll have to take a lifestyle cut in retirement.
Strategies For Generating More Income
As I discussed in The Retiree's Strategy to Portfolio Management, a properly diversified portfolio can provide both safety and return. If you still have a few years until retirement, but you're overweight "safe" assets, you may have room to incorporate smaller positions with higher return potential. Such investments include:
- High yield bonds, which offer annual coupon payments of > 6%
- REITs and in particular mREITs, which can offer fat dividend yields exceeding 10%
Of course, such positions should be moderate as they are fairly volatile. I believe high yield bonds should count as 15%-25% of "equity" allocations. I would not recommend REITs exceed more than 5%-10% in portfolio weight due to their volatility and inherent risk, but investors with strong risk tolerance may disagree.
Investors who still have a little time until retirement can defensively boost their income simply by investing in mega-cap dividend-growing stocks like Procter & Gamble Co. (PG), Johnson & Johnson (JNJ), The Coca-Cola Company (KO), or Colgate-Palmolive Co. (CL). David Templeton thinks these stocks are poised to outperform, and Tim McAleenan has some great analysis explaining how dividend investing can lead to an 11% increase in income in just 12 months.
Many dividend stocks are currently available at attractive valuations: Intel Corporation (INTC) offers a 3.3% dividend yield at a dirt cheap P/E of 10.7, Walgreen Co. (WAG) sports a 3.6% dividend yield at a P/E of 10.5, and Chevron Corporation (CVX) has a 3.3% dividend trading at a P/E of only 7.85.
Investors may also consider investing unused cash holdings in taxable accounts in short-term (1-3 year) municipal bond funds. Such funds offer liquidity (you can easily withdraw in an emergency), but also offer tax-free yields of at least 1%. This isn't going to knock anyone's socks off, but it prevents some erosion of purchasing power via inflation.