By Allan Roth
September 15, 2016

As a financial planner, I often have people at or near retirement show me their portfolios that produce a seemingly rich income of 5% or more a year. These payments come from complex and risky investments, such as master limited partnerships (MLPs), high-yield bond funds, and private real estate investment trusts.

Most of these investors aren’t celebrating. That’s because they have lost far more of their principal value than they ever made in income. In some cases they have needed to lower their lifestyle or return to the workforce.

The instinct to build a portfolio that produces income is a powerful one. By retirement age you will have worked decades to build up your assets. The thought of flipping a switch and spending down that portfolio is very scary. Little wonder so many people say their goal is to develop a portfolio that produces a safe income to live on. They believe that’s the only way to guard against running out of money later in life.

Not so easy

When people ask how they can get that high, safe income, my answer is, “You can’t.”

Investments that deliver far higher yields than safe bonds such as U.S. Treasuries typically come with a significant price risk. For example, over the year through June 30, a group of exchange-traded funds that invest in energy MLPs, which typically own oil and gas pipelines, yielded 7.6% on average. But including a steep price drop, investors actually lost 18.5%, according to Morningstar.

Calculator: How do taxes and inflation impact my investment return?

A smarter approach is to take your investment risk in stocks and let capitalism work its magic over the decades of your retirement. Balance the risks of stocks with safe fixed-income assets, and give yourself permission to dip into the principal.

What to expect

While stocks are very volatile, I expect they will beat inflation by an average of four to five percentage points a year over the very long run. Pick index funds for diversification and low costs.

Read: 3 Ways to Lower Your Taxes in Retirement

For shock absorbers, buy bank CDs, funds that own investment-grade bonds, and also inflation-indexed bonds. Over time I expect these holdings to at least keep pace with inflation and maybe earn up to one percentage point a year more. The goal isn’t maximizing income, but providing stability and also dollars to put into stocks when they tumble.

You will sometimes be selling bond or stock funds to pay expenses, and that’s okay. I tell clients that money is simply stored energy. Over the years they work and save to convert human capital (their ability to make a living) to investment capital. Use your money. You earned it. And if your stocks grow over time, that will help finance your later years and leave dollars to pass on to heirs.

Allan Roth is a financial planner in Colorado Springs and the author of How a Second Grader Beats Wall Street.

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