Living Off Interest And Never Touching The Principal May Not Be A Workable Idea

Thursday, November 08, 2012 01:01
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Living Off Interest And Never Touching The Principal May Not Be A Workable Idea

Tags: client education | investing for income | investor behavior

Many investors tell advisors they want to live off of the interest generated by their investments but never want to touch the principal. The problem with this strategy is that it doesn’t work and never has, really.

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Most people wishing to live off of dividends are focused on capital preservation. But what exactly does not touching the principal mean?
 
Does it mean not letting the account balance get below a certain level? Or does it mean they never want their account balance to go down at all?
 
The problem is that most interest income streams vary more than most households can stand.
 
Using one-month T-bills as a proxy for high-quality interest-bearing instruments easily proves that.
 
For example, if a couple started retirement in the 1930s, 1940s, or 1950s, their income would have risen fairly steadily over a 30-year period. That sounds good but the income level was probably not enough to support their needs during the early years.
 
A couple retiring during the 1970s or 1980s would have seen their standard of living decline—steadily.
 
Those retiring in 2001 or 2007 would have seen their incomes reduced drastically almost immediately.
 
Add that marginal tax rates have been higher in recent years and you have an even greater need for growth to offset the taxes as well as boost income streams.
 
Longer maturity securities usually offer higher rates but they also offer greater risk since principal value fluctuates with the market before maturity.
 
Although it’s easier to tell clients what they want to hear, it’s often much better to tell them what they need to hear. Instead of being a negative experience, it can be educational and empowering for clients, giving them a more realistic idea of what it takes to succeed financially.

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