Many folks already retired or within sight of retirement are in the position of not having good alignment between their expected retirement expenses and their expected retirement income. I've written a handful of articles on planning for retirement and on saving/investing for retirement. Those articles can be found here, here, and here. Recently, I published an article that, rather than focusing on the planning and investment side, is focused on how to spend less in order to save/invest more during your accumulation years.
However, some folks still fail to plan or fail to implement their retirement plan and simply don't have sufficient income to retire. There are a number of steps that retirees or those soon to be retired can take in order to lower their expenses in retirement.
Retirees too often attempt to fill an income gap (expenses higher than income) by focusing on high yielding stocks and/or investing in highly out of favor stocks hoping for stellar returns when the company "turns around." While chasing yield and turnaround candidates can pay off, it does not happen very often in practice. The approach of building a diverse portfolio of dividend-paying stocks, bonds, ETFs, and mutual funds is a more proven approach to generating a sustainable income stream over many years or decades.
Downsizing can both reduce your monthly retirement expenses and free up cash for additional income-generating investments. It is a potentially powerful tool many retirees fail to utilize. What to downsize you ask?
The largest single asset for most retirees is their home. Houses are great wealth builders compared to renting your roof. Most homes rise in value over time and you are generally building equity in your home through all those mortgage payments you made during your working years. The question to ask yourself is whether you still need or want the same size home you currently have. A smaller home with similar appointments and interior finishes generally costs less than a larger home. The difference between the value of your current home and the cost of a smaller home could be invested to increase your monthly income. In addition to freeing up some cash tied up in your home, smaller and lower cost homes have lower carrying costs. Property taxes, homeowners insurance, utility costs, and maintenance costs will be lower for a smaller home. That will definitely improve your monthly cash flow. The table below is a spreadsheet I prepared with a real example for a retiring couple moving a couple of hundred miles to eastern North Carolina.
In the example above, the couple is moving from a home north of Charlotte, NC to the community of Cypress Landing in Chocowinity, NC. The Cypress Landing community has a clubhouse, a couple of pools, exercise facility, a marina, and an 18-hole golf course. This explains the YMCA Membership entry in the table above and the significantly larger HOA fee for the new house. The couple will be using the Cypress Landing community pool and exercise facilities and will forego the YMCA membership.
This relatively simple example saves the couple roughly $363 per month or $4353 per year. While this isn't going to make up for a major discrepancy between expected retirement expenses and expected retirement income, every little bit helps. Readers should also note that this is not a major change in home size going from roughly 3650 square feet to 2525 square feet.
Do you really need two, or maybe even three vehicles, during retirement? Vehicles are expensive to own and maintain. Shedding one of your vehicles will free up cash from a depreciating asset which can be invested to generate additional income and the maintenance and insurance bills will stop. Selling a late model vehicle could easily bring $20,000 (though this is highly variable) which, when turned into a 3% CD, will provide another $600 in annual income.
Foregoing the cost of insurance and maintenance on that sold vehicle could also net you an additional $1000 annually though this is also highly variable depending on where you live and where you get your vehicle maintenance performed.
I'm always amazed at how much "stuff" people accumulate sometimes filling up the garage and displacing their vehicles. Even though my wife and I have not accumulated a lot of "stuff" over the years, my recent efforts to downsize some of our "stuff" have paid off very nicely. Over the last couple of years, I've sold stuff on eBay, Craigslist, and GunBroker. In addition, we donated a number of things to GoodWill and the ReStore and deducted the contributions on our tax returns.
I did not keep stellar records on all the stuff we either sold or donated, but from the records I do have, I was able to collect at least $27,645. Those folks with garages and/or basements full of "stuff" should be able to recover more than I was able to collect.
Move To A Low Tax State
I've brought this subject up a couple of times in my previous articles and received what I would say are "mixed reviews." If you are going to go through the trouble of downsizing your home, why not get even more savings out of the move and relocate to a state more tax friendly to retirees? Some folks have embraced this concept with open arms even to the extent of retiring to a locale outside of the US where the cost of living is downright cheap.
I'm not suggesting quite that radical of a move as I put a high premium on our democratic republic form of government as well as my family's safety. Even within the US, the difference in state tax burdens on individuals is pretty wide. The table below shows the 10 states with the highest and the lowest tax burdens in the US.
The data in the table above was lifted from a WalletHub Website. The "Burden" in the table above is the percentage of income each state claims from the average citizen and includes state income taxes, property taxes, and sales taxes. Because this is an average, your particular results may vary depending on your specific sources of income in retirement. But, it is instructive to look at the differences in each state's tax "take." For example, moving from New York to Tennessee would net the average couple a difference of 7.57% or $3785 annually on $50,000 in income.
It is also worth noting that, in general, homes in Tennessee are considerably less expensive than equivalent homes in New York State. However, as I indicated above, your state's actual tax "take" will vary considerably with the sources of your income in retirement.
A good example of this is North Carolina versus South Carolina versus Tennessee. South Carolina offers retirees exemptions on retirement income including income from social security, pensions, IRAs and 401k accounts. South Carolina has a 7% top rate on income, a 6% state sales tax, and one of the lowest property tax rates in the US. In addition, South Carolina provides a retirement income exemption of up to $30,000 for a retired couple and a $50,000 exemption on assessed property value for local property taxes.
North Carolina just recently lowered the state income tax rate to 5.49%, does not tax social security benefits, and has a state sales tax rate of 4.75% (localities can add up to 2.75%). There is also a partial property tax exemption for those over 65 but it is income dependent and too complicated to list here.
Tennessee has had no tax on earned income for some time but did tax unearned income (interest and dividends) at up to a 6% rate. This tax is known as the Hall Tax. Tennessee also has a rather high state sales tax rate at 7% and localities can add up to 2.75% on top of that. Property taxes in Tennessee, while not as low as in South Carolina, are still some of the lowest in the country.
The Hall Tax on interest and dividends was not exactly friendly to retirees since retirees rely heavily on interest and dividends to supplement their income from social security. The Tennessee legislature finally got a clue and voted to phase out the Hall Tax a couple of years ago at 1% per year. The Hall Tax will be fully phased out in 2021 making Tennessee one of the more tax-friendly states.
So, which of the three states offers retirees the best deal from a tax standpoint? The answer is, "it depends." For those retirees with mostly pension, social security, and IRA/401k income, South Carolina probably offers the lowest overall tax rate of the three states. For those retirees that have significant income from non-qualified accounts, North Carolina may provide a lower overall tax rate because of the state's lower income tax rate of 5.49%.
If you are seeking to lower your state tax burden by moving to a low tax state, you need to do a little homework and look at how your retirement income stream will be taxed in your target state(s). A good place to start that homework is Kiplinger's State by State Comparison . Below is a non-interactive copy of Kiplinger's tax comparison map for retirees.
Source: Kiplinger's Website
Be sure to take the "tax friendly" vs. "not tax friendly" color-coded interactive map with a grain of salt because it does depend on the sources of your retirement income. Georgia recently threw its hat in the ring to compete for retiree tax-friendly status with exemptions on retirement income. Unfortunately, states like Connecticut and Illinois are going in the other direction.
I should also note here that the recently passed Republican-sponsored Federal income tax changes made living in high tax states potentially more expensive for retirees. The cap on state and local taxes (SALT) limits the deduction for state and local income taxes and property taxes to a maximum of $10,000. In states like New York, New Jersey, Connecticut, California, Pennsylvania, Massachusetts, and Rhode Island, that $10,000 cap will impact a significant number of retired or soon to be retired homeowners.
My brother-in-law lives in Alleghany County, Pennsylvania in a nice but not extravagant home. His property taxes alone are over $12,000 per year. The bottom line is that it is worth considering a move to a lower tax state as it could significantly lower your overall tax burden.
Investing During Retirement
If you are one of those extraordinarily few investors that can routinely beat the market, read no further. This section is not intended for you. If you are one of the chosen few, please contribute articles on SA so the rest of us can learn how you do it. In all seriousness, very few investors routinely beat the market averages, in particular, the S&P 500 Index. And while we absolutely don't want to admit it, as we age, we lose some mental capacity and our minds are not as sharp as they once were. So, this section offers advice on how to simplify and diversify your retirement portfolio; in a sense, make it more bulletproof.
Don't Chase Yield
I can't put it any more simply than "Don't Chase Yield." Most retirees want to collect as much income as possible from our investable assets. It is possible to find yields in excess of 10% from stocks and from a few bonds. But, in almost all cases, yields that high, to borrow a phrase from Brad Thomas, are "sucker yields." The underlying securities may pay those yields for a time but in today's environment of 3% 10 year Treasuries, a 10%+ yield simply is not sustainable.
I've read a number of comments on SA that say essentially "I don't care about the principal, I'm just in it for the yield" as justification for investing in a high yield equity with a weak balance sheet and out of favor with the market. Honestly, this is the opposite of what you should be doing as a retiree. To borrow another of Brad's often used phrases, "Protect your principal." When the economy turns down or we have another recession, those high yields will likely evaporate and you will be lucky if you get your principal back.
When you were young and earning a good income, you had both time and another income source on your side. Now, in retirement, you don't have the time to recover from a major market turn down and may not have another source of income to plug the gap. So, rather than chasing yield, invest in solid companies with a strong balance sheet that have a record of pulling through major market downturns and recessions. Retirees should be looking at equities with a history of dividend growth in both up and down markets.
You could do a lot worse than picking from the list of Dividend Aristocrats. Examples from that list include some of my favorites 3M (NYSE: MMM), AT&T (NYSE: T), Beckton, Dickinson and Company (NYSE: BDX), General Dynamics (NYSE: GD), Lowe's (NYSE: LOW), and Walmart (NYSE: WMT).
Note I am not advocating running to the nearest computer and placing buy orders for these stocks. I think BDX and GD are fairly valued at this time, the rest of the list above and much of the market is not. I'm currently only holding GD and T from this list but with enough of a market correction, I'd be looking to add any and all of these names to my portfolio.
Don't Chase The Next "Turnaround Stock"
True "turnaround stocks" are a rare animal indeed. It takes a lot of management talent, time, capital, and favorable economic conditions for a successful turnaround and those ingredients are often not present at the same time. A couple of recent articles on SA singing the virtues of the "turnaround stock" with 50% to 60% upside tipped me over the edge into including this section in this article. I'll not give the title or name the authors as I'm sure they wouldn't appreciate my negative viewpoint on potential turnaround stocks.
But the two companies are General Electric (NYSE: GE) and Newell Brands (NYSE: NWL). In the case of GE, the particular article was published a few months ago when GE was supposedly forming a bottom at $15 per share. I offered in the comments that GE was very likely heading lower as the bad news was still being discovered. It is now obvious how that has turned out.
NWL is a very different animal than is GE. NWL is a consumer products giant and got that way almost exclusively through acquisitions. It has found itself with weakness in some sectors of its business, a bloated balance sheet with interest rates on the rise, facing stiff online competition, and with new tariffs on many of its imported Chinese products. The market has soured on NWL and it has dropped from the low $50 range to just above $20.
Now, with tariffs on the books and good prospects for even higher tariffs (up to 25% from current the 10%), NWL is a "turnaround stock." NWL is trying to raise capital by selling off companies and product lines it acquired less than 3 years ago and management is paying attention to the issue, but the economic conditions for NWL are simply poor at the moment with tariffs in place on its products and higher tariffs likely in a few months.
Both of these companies may, at some point, find a bottom and successfully turn their respective businesses around. In my view, I see nothing that would indicate either company will be turned around any time soon with NWL in particular likely to see more downside as the tariff tit-for-tat with China continues.
In general, very few investors have the where-with-all to make money on turnaround candidates. That kind of due diligence is simply beyond most investors so I view most of the cheerleading for turnaround stocks as little more than hope. Hope has never been and never will be a good plan for your investments.
Pursue Diversification In Your Investments
Diversification in your investments provides many benefits. You will get more consistent returns and lower volatility with a well-diversified portfolio. You will lower your risk of large losses in your portfolio, something that most retirees cannot afford to experience. And probably most important, you will sleep better at night knowing all the above benefits apply to your portfolio.
As important as diversification is, it is not that easy to achieve with a portfolio of individual stocks. Because you need to diversify across equity sectors as well as within each sector, you need to own a fairly large number of individual stocks. In addition, it is wise to have diversification across asset type as well. Ideally, you should hold both stocks and bonds in your retirement portfolio. That makes creating and maintaining a truly diversified investment portfolio a non-trivial challenge. There is a much easier way to get the desired diversification.
Most mutual funds, ETFs, and CEFs come with some level of diversification. Note however that sector funds may be well diversified within the sector (e.g. healthcare) but lack diversification across sectors (e.g. financials, energy, industrials). My stock portfolio is not diversified and it reminds me of that fact frequently. With heavy concentrations of REITs, energy, and utility stocks, days like today show a lot of red in my stock portfolio.
For reference, today is the day the Federal Open Market Committee announces their expected overnight interest rate hike. I do however enjoy the dividend stream that my individual stock portfolio throws off. Instead, I achieve diversification through investments Vanguard Group mutual funds.
Vanguard has an S&P 500 Index Fund (NASDAQ: VFINX) whose performance tracks the index very closely as expected. Over the long haul, you would have a difficult time finding an investment that would provide better returns and comes off the shelf with a high degree of diversification. Another favorite of mine is the Vanguard Wellington Fund (NASDAQ: VWELX). The Wellington Fund is a balanced fund with roughly 60% of assets in equities and 40% in fixed income assets so I get diversification across equities and bonds.
If you look at the historical performance of the Wellington Fund, you will see that it has provided consistently good returns with relatively low volatility over a very long period of time thanks, in part, to a very high level of diversification. I also invest in the Vanguard Dividend Growth Fund (NASDAQ: VDIGX), the Vanguard Mid Cap Growth Fund (NASDAQ: VMGRX), the Vanguard Capital Opportunity Fund (NASDAQ: VHCOX), the Vanguard Energy Fund (NASDAQ: VGENX), and the Vanguard Energy ETF (NYSE: VDE).
The latter two funds are rather recent additions as I fully believe we are past the "lower for longer" crude oil price period and those companies whose business is production and delivery of primary energy will do well over the next couple of years.
Readers will note that VDIGX and VHCOX are both currently closed to new investors. Vanguard periodically closes funds when the fund manager can no longer find equities at fair valuations. While this annoys some investors, I appreciate this policy as it helps prevent investors putting money into a market or sector that the professional fund manager believes is currently overvalued.
Vanguard generally reopens closed funds when market valuations drop to levels where the fund manager can deploy additional funds and expect a reasonable return going forward. Readers will also note that the only index fund in my list above is VDE. I strongly favor managed funds over index funds with VDE being an exception.
The same caution about running out and investing tomorrow in the Vanguard funds listed above applies here. My view is that, in general, the market is above fair value. I'm actually leaning slightly on the side of raising cash versus making any large new investments. I have the patience to wait for a better entry point.
For those folks currently retired and looking at it on the horizon that can't quite close the gap between expected expenses and expected income in retirement, there are options available to lower your retirement expenses. Downsizing your home, your vehicles, your "stuff," and moving to a lower tax locale can easily cut your expenses by $10,000 to $15,000 per year. Research will be required on your part to ensure you understand the tax consequences of a change in state residency based on the types of income that fund your retirement.
In setting up your investment portfolio for retirement, a few simple rules will go a long way in helping you avoid expensive mistakes.
1. Don't chase yield.
2. Don't chase turnaround stocks.
3. Pursue diversification within business sectors, across business sectors, and across asset types.
These simple rules will additionally help you sleep well at night and better enjoy your retirement years.
Disclaimer: This article is intended to provide my opinion to interested readers and to serve as a vehicle to generate informed discussion in the comment posting. I have no knowledge of individual investor circumstances, goals, portfolio concentration or diversification. Readers are strongly encouraged to complete their own due diligence on any stock, bond, fund or other investment mentioned in this article before investing.
Disclosure: I am/we are long T, GD, VWELX, VDIGX, VMGRX, VHCOX, VGENX, VDE.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.