How do Retirees define "income"? It's not what Wall Street Thinks by Scott Stolz (week 25)

 

 

 

Every week Barron’s does a column called “Income Investing”.  As a retiree, income is important to me, therefore I always check to see what they suggest as a possible income solution.  The problem is that like I mentioned in week 13 (Retirement "Income" or Retirement "Paychecks"? - (week 13), Wall Street’s definition of “income” is very different from mine.  I’ve incorporated lifetime guaranteed income into my retirement plan that I plan to turn on when I reach the age of 68.  This “income” will be provided by Social Security and 3 different annuities.  Each will deposit money into my checking account that will become the source to cover my essential expenses and most of my discretionary expenses as well.  Until age 68, these expenses will be covered by an inherited IRA that the tax codes says I must liquidate anyway. 

In contrast, Wall Street defines income investing as any security that pays out money.  Think interest on bonds and dividends on stocks.  But do investors really think of this as “income” that they are comfortable spending?  I don’t think so.  Let’s go back to Barron’s “Income Investing” article.  On October 27, the article was entitled “The Other Reason to Buy Dividend Stocks”.  Sharon Hill, one of the senior portfolio managers of Vanguard’s Equity Income fund was quoted as saying “…most of our investors have an auto-reinvest feature turned on” for the dividends paid by the fund.  The article goes on to state that “income-oriented investors are no more likely to withdraw dividends than those in ordinary equity funds, with some three-quarters of the former opting to reinvest their payouts.”  Since this seems contrary to what one would expect income investors to do, Hill commissioned research to be done in order to find out why.  The answer was simple.  “She discovered that investors view dividend-paying funds as a way to diversify their portfolio.”  In other words, most investors don’t view dividends as income at all.  At least not in the sense of spendable income that I need to cover my expenses in retirement.  To most investors, dividends are just another form of return on their investment portfolio.  And I suspect that they view bond income in much the same way. 

Most advisors believe they have built retirement portfolios that can generate sufficient “income” to cover their client’s income needs in retirement.  Therefore, annuities are an unnecessary addition.  And from a portfolio construction point of view, they are probably right.  There is only one problem – their definition of “income” differs from their client’s definition of income.  And that is why so many retirees underspend in retirement.  The numbers might indicate that they can safely spend stock dividends and bond interest, but unless this “income” is deposited directly into their checking account, they are not likely to spend it.  Because as one friend on the verge of retirement told me this week “you can’t ever really know if you have enough.”  On top of that, bonds mature and get called, interest rates change and dividends can get cut or even eliminated.  They are hardly secure sources of lifetime income.  Perhaps the correct answer is to not call them income at all.  Perhaps it’s time that Wall Street changes the phrase “income investing” to “diversification investing”.