6 Retirement Financial Myths to Avoid

By the time you retire, you will have heard and read about all kinds of financial advice. Some tidbits of advice get repeated so frequently, you might believe they are true. The truth is, however, that following some of these rules could get you in trouble. Here are six financial myths you should ignore.

1. You Should Live Off Your Income and Not Touch the Principal

Adhering to this strategy will leave you exposed to inflation shortfalls. In order to generate sufficient income to cover cash flow needs, you’ll need to invest primarily in bonds. Sure, you’ll have income, but your principal won’t grow.

For example, let’s say you have $2 million in retirement savings and you need annual cash flow of $80,000 a year. You invest your nest egg in bonds returning 4% a year. In five years, you’ll still get $80,000 a year, and you’ll still have $2 million. But after 3% inflation, you’ll need almost $93,000 to support your lifestyle. That leaves you with two choices: Reduce your expenses every year or eat into principal.

What’s better is to invest in a diversified portfolio. Let’s say instead of investing in bonds, you invest in a diversified mix of stocks and bonds. The portfolio grows at 5% a year and generates income of 2% a year. This leaves 3% for growth, which will offset inflation.

2. Get Your Cash Flow From Bond Interest and Stock Dividends

In addition to the issue of inflation, this tactic ignores the impact of taxes. Interest income is taxable as ordinary income. For those who might point out that municipal bonds are not taxable, remember that their return is less (a “tax haircut”). Stock dividends are taxed at capital gains or ordinary rates, depending on the type of dividends.

If your portfolio produces less income and more appreciation, your annual tax hit will be less.

3. Hold Bonds in Percentage Approximately Equal to Your Age

This rule might have been a good idea when people only lived to their mid-60s. With life spans increasing, holding too much in bonds could leave you with an inflation shortfall. Rather than base your bond percentage on your age, consider an allocation that matches your financial needs and risk tolerance.

4. Limit Your Draws to 4% (or 5%) a Year From Your Portfolio When You’re Retired

An exact number for a safe withdrawal rate is debatable. According to recent articles, it could be as low as 3% and as high as 5%. In reality, there is no “one size fits all” rule.

In my opinion, spending slightly on the high side (5%) in earlier years is fine. This considers several factors:

• You don’t have to plan for the worst case.
• You likely have safety nets, such as home equity.
• You will likely spend less over time.

Assuming your medical and long-term-care expenses are covered by Medicare and insurance, it is a safe assumption that your retirement cash flow needs will decline as you age. So, to ensure you don’t shortchange your activities during your early retirement years, you should build declining expenses over time into your financial plan.

You should also consider annuity-type investments, such as Social Security, defined-benefit pensions, reverse mortgages, and deferred or immediate annuities.

Finally, you must be willing to be flexible. During times of large market drops—especially in the initial years of retirement—temporarily decreasing expenses might be required.

5. You Don’t Need a Financial Advisor

Unless you have unlimited resources, a financial advisor can help ensure that your investments last throughout your lifetime. Financial advisors can provide you with a cash flow plan, check your insurance coverage, look for estate planning issues, and help you with ongoing questions such as whether to lease or buy a car.

Trying to save money on an advisor could put your retirement in jeopardy. To find a fee-only advisor, check out this search tool from the National Association of Personal Financial Advisors.

6. You Need an Investment Manager

Believe it or not, not every retiree needs an investment advisor. If over 90% of your investments are in IRAs, you could simply buy an asset-allocation fund (like one of the Vanguard LifeStrategy Funds). Because your portfolio is primarily held in IRAs, you don’t need to worry about tax consequences. And a low-cost asset-allocation fund will automatically rebalance your investments.