Be an Owner Rather Than a Loaner in Retirement

June 26, 2014

One of the most common pieces of investment wisdom is that you should invest more in conservative “loan” investments like cash and bonds and less in more aggressive “own” investments like stocks and real estate as you get closer to retirement. This may have made sense when bonds were paying 6% or more but with long term bonds rates now closer to 3%, this could actually make it harder to retire comfortably or more likely you could run out of money in retirement. Cash is paying less than inflation. Rather than to low-interest bonds and cash, why not shift towards high-yielding dividend stocks and real estate? Here are some advantages of this approach:

1) Higher yields. The historical case for bonds is that they paid more income than stocks but you can find stocks paying above 4% in dividends and REITs and rental properties yielding even more.

2) Safer yields. Bonds have also been thought of as a safer source of income but think about the retiree who had bonds paying 6% that matured and had to reinvest in bonds paying only 3%. Their income was cut in half, perhaps for a very long time. In contrast, there are many stocks that have never cut their dividend and those who did during the financial crisis typically restored them pretty quickly, while bond rates have yet to come back.

3) Increasing yields. While bond rates have fluctuated up and down over the years, dividends and rental yields have generally increased over time even faster than inflation over. Even if bond rates don’t go down any further and just stay the same, you would lose purchasing power over time due to inflation.

4) Lower taxes. Interest income is fully taxed as ordinary income. Municipal bonds are tax-free but pay even lower yields. Qualified dividends are taxed at capital gains rates, which can be 15% for taxable incomes below $36,900 for singles and $73,800 for joint households. When you consider that Social Security isn’t fully taxable and about $10k of income per person will be tax-free due to exemption and deductions, it might be easier to stay within that 15% bracket than you think.

5) Appreciating value. Stocks and real estate tend to grow not just their incomes but their values as well. Even if you never sell them, your heirs will likely appreciate this. Bonds just fluctuate up and down and given how low current rates are, may be more likely to fluctuate down than up.

Of course, stocks and real estate tend to be more volatile than bonds. But if you’re willing to hold on to them and just live off the income, they can pay off in the long run. So consider being an owner rather than a loaner in retirement.