An issue that plagues many retirees is how to manage retirement income in the face of the increasing cost of living. Even with moderate inflation, costs of living tend to increase over time. This can reduce the retirement income retirees can obtain from fixed income investments, even while they must meet higher expenses. Where can you find a source of retirement income that can keep of with inflation, along with your expenses?
Our suggestion: consider putting some of your money into a portfolio of large capitalization dividend-paying stocks as an income generation alternative. This retirement investment could help to provide you with a retirement income that keeps pace with the rising costs of living. For the 30 years ending 12/31/04, the stream of dividends from an investment in a basket of stocks representing the S&P 500 index generated a growing stream of income. During that same period, interest rates from CDs fell 7.42% to 1.85% (the S&P 500 is an unmanaged group of securities considered to be representative of the stock market in general; it is not possible to invest directly in an index).
Data 1/1/75 through 12/31/04. Dividends based on a $10,000 investment 1/1/75 in a basket of stocks representing the S&P500 from American Funds Distributors. Interest rates from Federal Reserve year end rate on 6 month CDs. You cannot invest directly in an index. Past performance is not a guarantee of future results and an analysis of a different period may have revealed different results.
Although publicly traded stock can help you to manage inflationary risks, the dividends that these stocks pay out are highly dependant upon the overall profitability of the issuing company. Therefore, you will want to strongly consider the dividend payment history of the company prior to making such a retirement investment.
A few additional things should be considered about stocks and CDs. First publicly-traded stocks tend to be suited for investors that are seeking asset appreciation and are willing to take on the additional investment risk. On the other hand, CD’s are suited for investors that are concerned about preserving their principal investment and are adverse to market risk. With this in mind, it should be remembered that CDs are FDIC insured while publicly-traded stocks are not. The values of publicly-traded stocks fluctuate in value and may result in either a gain or loss upon sale.
The retirement income from these investments is also subject to differing income tax rules. Stock dividends are generally subject to federal income tax of 15%, while CD interest is taxed as ordinary federal income tax rates, which can range anywhere from 10-35%. CDs may have an early withdrawal penalty if money is taken prior to maturity. On the other hand, the stock of most largely capitalized companies can typically be purchased and sold at any time when the market is open.
But as you can see from the chart at http://www.retirement-income.net/income_basics.html, stocks beat CDs hands down for retirement income.