Wealth Based vs. Income Based Portfolios

There are a lot of differing opinions about how to construct a long term investment plan – some go for a fixed total amount (indeed this option is the backbone of advice from financial institutions who have a clear interest in gaining large deposits), others want sufficient income for financial independence that will not reduce their capital.

Wealth-Based Investing

One million dollars was always the target for a retirement account and today it probably is considerably more.  This option allows for a 4% withdrawal rate on the total financial assets each year.

This means you need to save roughly 25 times your expected annual expenses.  Thus $1M allows you to withdraw $40,000 per year and $2.2M will give you $100,000 per year.  Disadvantages of this plan are:

  • You need to start early in life, or contribute a great deal more of your income in later years to amass the target amount by your retirement age.  For example:  Assuming an annual return of 8%, 21 year old Dayle can contribute $167 per month for 44 years, but 40 year old Jamie needs to deposit $815 monthly for 25 years for the same grand total.  Interestingly, if the rate of return drops to 5%, Dayle’s deposit climbs to $525 and Jaime must come up with $1,660.
  • It’s difficult to accurately predict variables such as investment returns, rate of inflation, tax rate, unforeseen future expenses, and health and longevity, especially the further away you are from retirement.
  • A severe market downturn can drastically erode capital in your stock or mutual fund portfolio just when you need it.  As a precaution, many people close to retirement convert to a fixed income portfolio but will then lose the greater growth potential of equities.
  • If the funds are held in a RRSP or RRIF the total amount withdrawn is taxed at your highest tax rate, as is interest from fixed income sources.

Income-Based Investing

On retirement, employment income must be replaced.  Unless you are fortunate enough to receive royalties from a creative endeavor, this usually means supplementing income from a defined benefit plan or defined contribution plan with investment income.

A rule of thumb is to receive 60% to 80% of pre-retirement income.  Disadvantages of this method are:

  • You still have to amass a fair amount in order to have sufficient capital to earn the interest or dividend amount you require.
  • Good quality blue chip companies regularly increase their dividend payments, but there could be occasions where dividends are reduced or eliminated altogether.
  • Unexpected medical bills or other expenses can force you to dip in to your principal amount if you haven’t calculated sufficient monthly income to cover them.

Personally, I’m working at generating enough monthly income to fund my retirement years.  I suspect that most people will do some combination of the two methods.


Related: The Best Time To Start Saving Is Now

Consult with your financial professional to determine your personal calculations (for DIY investors there are a lot of resources available).  The goal for everyone is to have the financial resources to live an active, healthy life doing what they love best.

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  1. Gary on February 8, 2011 at 9:09 am

    Boomer, are you trying to give me a heart attack? We retired more than 4 yaers ago with far less than $1M AND WITH NO PENSION! My attitude was — if I wait until I have enough I will never retire and I am not getting any younger. I am 64 now and we have done some very nice trips and we spend the winter in South Carolina in our RV. We feel we have about 10 years left of travelling and then we will probably stick close to home. Our home should finance our retirement home and if not, look out daughter or son here we come. You guys have the best blog on the internet — I look forward to it everyday!!!

    • Boomer on February 8, 2011 at 5:22 pm

      Hi Gary. It sounds like you are in the same position as I will be in a few years. I also don’t have anywhere near $1M in investments and the pension I will get may let me go out for dinner once or twice a month. I also would like to spend several years travelling before I settle down and like you, my current house should pay for a nice little retirement home. Thanks for your support.

  2. Evan on February 8, 2011 at 2:37 pm

    Have you ever thought about creating your own pension with an insurance based product?

    • Boomer on February 8, 2011 at 5:24 pm

      Hi Evan. I have never had investments together with any insurance products so I have not considered this. Maybe it’s something I need to look into. Thanks.

  3. Balance Junkie on February 8, 2011 at 3:42 pm

    This is a really interesting comparison Boomer. I’ve never heard it put quite that way before. There are so many variables to think about in retirement planning, but this is a great place to start. Thanks for the information!

    • Boomer on February 8, 2011 at 5:29 pm

      Hi Balance Junkie. As I’m thinking a lot about retirement these days funding all that leisure time has been on my mind – can I afford it now or should I still wait a couple of years? Deplete my RRSP early or wait for dividend income to be greater? It’s a lot to think about.

  4. My Own Advisor on February 8, 2011 at 7:57 pm

    Good post.

    No doubt, income must be gained somehow in retirement. Options with the RRSP; hold on as long as you can, until you can cash it in at a much lower (tax) rate; use lots of TFSA contribution room put some ETF products in there to spin off some cash; convert your RRSP to a RRIF. Annuities are another option for income, defined but locked-in.

    Geez, certainly lots to think about.

    I’ve been talking to my parents of late about their “plans”, they are in their early 60s and it’s quite interesting to learn from them; what they thought they would have vs. what they actually have in terms of income. Seems for years their expectations were pretty high, only for reality to set in. They’re doing fine, but it’s an adjustment for them for sure as new retirees.

    It would be interesting to read in your future posts, what you biggest dilemmas are and how you’re planning to break down those problems into smaller manageable solutions.

    If you have a paid off home, up to 80% of your pre-retirement income, although high, seems like it would be plenty. 30% of our current living expenses go to our mortgage. I need to get that puppy paid off 🙂

    • Boomer on February 9, 2011 at 9:50 am

      My Own Advisor: you’re right in that there is lots to think about, especially regarding being tax efficient. After my parents retired they received several income sources – from company pensions to foreign pensions. In fact my dad claimed he received more income after 65 than when he was actually working. I certainly won’t be in that position! Being able to live in your “free and clear” home is one of the best retirement strategies.

  5. The Dividend Ninja on February 9, 2011 at 10:54 pm

    Boomer, good post! You and Echo write excellent articles..

    I think in these times of uncertaintity that combined strategies will be the winners. I’m a big proponent of both Passive Index Investing and Passive Dividend Investing – becuase both strategies provide growth and income. When one does really “retire” then GIC’s make the most sense to preserve capital – yes you will erode income, but you won’t lose your shirt either in another 2008.

    Personally if I have enough retirement income to live on great, but I’m not counting on it – hence I will create 500 blogs that generate ad revenue 🙂

    • Boomer on February 10, 2011 at 5:05 pm

      Dividend Ninja: I like the idea of having enough income for my monthly needs with a BIG cushion for the unexpected wants and needs. Having some form of passive income is the way to go – maybe I’ll write a bestselling book and rake in the royalties 😉

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