How to Live from Accumulated Income

How to Live from Accumulated Income

by Thomas L. Hardin, CMT, CFP, Managing Director, Canterbury Group


(Note: This is Part 2 of a two-part series on longevity planning.)


Last month we talked about visioning your later life. Will you stop working entirely? Transition to a new passion or pursuit? Turn a hobby into a second career? No matter what you choose - and the options are endless! - you'll have to figure out how to support yourself. Where will the money come from? Will you need to tap into your accumulated assets? If so, how you go about it will make a huge difference.


There are some popular myths about tapping into assets. One says that when it's time for your portfolio to supplement expenses, it should generate income rather than growth. In other words, you should change your portfolio when you need to pull from it. Another says your stock-to-bond ratio should be determined by your age. Let's take a look at what's wrong with these myths.


If you focus on growth in your early years, you subject your portfolio to market risk. You could even lose a significant portion of your principal (as many people did in the last few years). If you focus on income in your later years, you subject yourself to the risk of inflation. Let's say you put $100,000 in a bond that pays 5% interest and matures in 10 years. That may sound good today, but even if you don't increase your spending, inflation will raise your expenses. If you don't believe it, just think back to what it cost you to live 10 or 20 years ago and what it costs today. Inflation is the biggest risk you'll ever face. There are also at least two additional risks. If interest rates go up, your bonds drop in value. If rates go down, you'll be reinvesting the bonds at lower rates when they mature.


In the later years, most people think they need to avoid market risk in order to produce income. They believe it's an either-or proposition. In truth, there's another alternative, which Jim Collins, in his book Good to Great, referred to as "the genius of AND."


By diversifying your investments among and within different asset classes, you can achieve both growth AND income at the same time. The most efficient portfolio (the highest return with the lowest risk) is diversified. In other words, no matter how old or young you are, your portfolio should look fairly similar. The question then becomes, how do you pull from your portfolio to supplement expenses?


Investments can be broken into three categories of liquidity, and a diversified portfolio contains all three:

  • Liquid: Cash equivalents
  • Semi-liquid: Financial assets like stocks, bonds, and CDs
  • Non-liquid: Assets that don't have a "ready" market for liquidation, like personal assets, real estate, or a business

To supplement your income, remove funds from the area that's most tax efficient and incurs the least amount of negative impact, or maybe even a positive one. Generally, this means transferring money from specific securities in the semi-liquid category and moving them into a money market fund to meet your cash needs. There are several factors to consider, and your advisor should be able to help you choose wisely. The options are endless but the goal is always the same: to supplement your income by drawing funds from the most efficient place.


Bottom line: Your need for income should not drive your portfolio's structure. With the "genius of AND," you can manage the portfolio in a way that generates the highest return with the lowest volatility, AND pull the money out as you need it.