Last month's newsletter introduced my philosophy and strategies on investing for retirement, both of which have been influenced by studying the effects of the stock market crash of 2008-2009 as well as prior downturns.  As you read last month, these ideas aren't new--they're classic asset allocation and investment strategies.  In this newsletter, we'll continue to review these traditional strategies, but we'll refine the lessons to apply to today's environment.  Naturally, there are other investing philosophies and strategies out there that could work for you, but my focus is on time-tested strategies that work for your retirement years.  If you'd like to expand your knowledge base, I encourage you to learn from others and develop strategies that work for you.

The New Goals

Many investing strategies focus primarily on building wealth, which is an appropriate goal during your wage-earning years.  As I discussed in last month's newsletter, during your retirement years or the years immediately preceding your retirement, I advocate that you shift your attention to building reliable sources of lifetime income, no matter how long you live and no matter what happens in the economy.

In addition, here's another key goal: Arrange your finances so you won't be forced to sell your assets to pay for ordinary living expenses when these assets are depressed due to a market downturn.

With these goals in mind, let's review...

The Recession-Proof Investing Strategies

If you're within ten years of retirement or are already retired, it's critical to strike a balance between protecting your assets against two potentially significant risks: market losses and inflation.  The following two investing strategies address that goal:

1.     Manage your risks through asset allocation.

2.     Shift to investing for income. 

In last month's newsletter, I covered the first strategy.  Now it's time to get into the details of the second strategy.  

How Does The Strategy Work?

The overall goal of the second strategy is to put more of your assets in investments that generate income--stocks that pay dividends, bonds that pay interest, and real estate that generates rental income.  If you don't have the time or expertise to select specific investments--which describes most people--then invest in mutual funds or real estate investment trusts (REITs) that have the objective to generate income.  In this case, the website of Morningstar (www.morningstar.com) is a good source of information on mutual funds, including historical performance and ratings.

This investing strategy can be coupled with an effective strategy to draw down your retirement savings to pay for living expenses: Live on the investment income with no principal withdrawals.  This strategy is virtually guaranteed to protect you against outliving your assets, which is a significant concern in retirement.  In today's investing environment, this strategy can generate an annual retirement income that ranges from 2% to 4% of the value of your assets, depending on your allocation between stocks, bonds and real estate. 

A refinement of this strategy is to live on the investment income in your "early" retirement years, for example, until your sixties or mid-seventies.  If you need more income during this period to cover your living expenses, then work part time while you're still able.  After it becomes difficult to work, perhaps in your mid-seventies or later, then you can begin withdrawing principal.  See my March newsletter for more on effective drawdown strategies for your retirement savings.

By the way, working during your retirement years need not be as bad as it sounds, especially if you seek work that's enjoyable and allows you time to pursue your interests.  See this month's video highlight for provocative evidence of the benefits of working in your retirement years.  I'll have more ideas on working part time in your later years in upcoming issues.

Why Invest for Income?

Here are some good reasons to invest primarily for income:

• As I mentioned above, living on your investment income provides a disciplined strategy for making your retirement savings last for your life.  Also, if you're not withdrawing principal, you're not forced to constantly decide which assets to sell (and possibly pay capital gains taxes for investments outside of 401(k) and IRA savings).

• If you're living just on investment income, you don't need to sell assets when they're depressed by a market downturn.

• The dollar amount of dividend income from a diversified portfolio of stocks, bonds and real estate can be less volatile than the underlying value of these investments.  Also, stocks with a solid history of paying dividends have been less volatile than stocks that don't pay dividends.  This can give you some peace of mind when the market declines, giving you the confidence to ride out the downturn.

• Qualified dividends from stocks have a lower federal income tax rate--15%--than ordinary income, which is taxed at rates of up to 35%.  The 15% rate is the same rate as applied to capital gains.  These rates apply to investments held outside of 401(k) or IRA savings.

Refinements and Cautions

If you follow this suggested strategy, you'll want a substantial chunk of your investments to be in stocks that pay dividends--from one-third to two-thirds of your assets, as suggested in the October newsletter.  This enables you to get the most out of the lower federal income tax rate and protect against future inflation.  Having said that, stocks that pay unusually high dividends might be in financial trouble.  So you'll want to pay particular attention to the financial strength of the company as well as the ability of the company to pay dividends into the future.  Mutual funds with the stated objective of dividend growth typically invest in strong companies with a good history of paying dividends. 

It's also important to note that interest rates and the resulting income from government bonds and bank savings accounts can drop dramatically, as has been the case recently due to the federal government's efforts to stimulate the economy.  Interest rates from corporate bonds, however, have seen less dramatic declines.  So you'll want to consider investing a good portion of your assets in corporate bonds with good financial strength ratings; you can find mutual funds with this stated objective.

Having said that, if the economy ever gets to the point where interest rates are high, don't celebrate and spend all your newly increased interest income.  In this situation, interest rates might be anticipating high inflation, and you'll want to save part of your investment income if inflation returns, or if interest rates drop again. 

Because dividend or interest income can drop during times of economic distress, you'll want to have a diversified stream of retirement income that includes sources that don't decline in a recession: pensions, annuities, and Social Security income.  See my May newsletter for more details on this strategy.

One last caution: It's likely there will be changes in federal income tax laws in the next few years.  If the government returns to the prior practice of taxing dividends at a rate that is higher than the rate on capital gains, this could reduce the attractiveness of dividend-paying stocks.  So it's smart to watch if this undesirable feature is considered seriously in the debate in Congress on tax legislation, and plan accordingly.

If You're Withdrawing Principal...

In order to cover living expenses, some of you may need to withdraw larger amounts from your retirement savings than just the investment income.  In this case, you should prudently withdraw principal in amounts that minimize the odds you'll outlive your savings.  You'll need a good cash management strategy to avoid being forced to sell assets to cover ordinary living expenses when markets are depressed.  Here are the steps you can take to implement this strategy:

•  Pick a period of time to "immunize" your finances against future market declines, say from two to five years.

• For that time period, estimate your required principal withdrawals by projecting your total living expenses and subtracting sources of regular, reliable income.  The latter would include income from pensions, annuities, Social Security, and investment income.

• The net result is the amount of your future principal withdrawals--and the amount of assets that you'd want to keep in safe investments that don't decline or won't decline very much.  The first category includes money market funds, bank accounts and individually purchased TIPS (Treasury inflation-protected securities) held to maturity.  The second category includes short to medium-term bond mutual funds or TIPS mutual funds.

This strategy helps prevent panicked selling to meet living expenses, which can give you peace of mind that you can ride out market downturns.

The Ultimate Goal

Many people currently in their fifties, sixties and seventies will live well into their nineties, and maybe even to 100.  While you might normally think this is good news, it won't be if you run out of money in your eighties.  To be retired for 20 to 30 years or more, it will take smart money management--plus a lot of money to start with! 

Also, based on the past few decades, it's reasonable to assume that more downturns are likely to occur in our future, so it's wise to adopt strategies that will help you survive these events.  That's why I integrate smart lifestyle strategies--working longer--with the investment and drawdown strategies described here.  These strategies are designed to give you the confidence that you can live long and prosper!