Clients who don’t have an established career to depend on must find a way to generate income from a divorce settlement that will last a lifetime – even in tough market conditions.
By Sherry W. Campbell, Divorce Financial Analyst
Divorce can be financially devastating for all parties involved, but especially so for the spouse that chose to forego a career to raise a family. In most cases, this is the wife; research has found that about one in five women falls into poverty as a result of divorce.
For those that don’t have an established career to depend on, the money that they receive in their divorce settlement may very well be the only money they have to live off of for the rest of their lives. For these divorcees, it is imperative to find a way to generate income from a divorce settlement that will last a lifetime, even in tough market conditions. With the current market conditions, strategies once considered reliable are now seen as risky.
Common Investment Strategies Carry Too Much Risk
Traditionally, what is known as the 4% rule has been the sure way of creating sustainable retirement income. The 4% rule presumes that if you invest in a portfolio with moderate risk of 60% stocks and 40% bonds, you should be able to withdraw 4% (increasing the amount to keep pace with inflation) of your assets and have a 90% probability of not running out of money over a 30-year retirement.
However, because of volatile markets and low interest-rates today, most professionals no longer consider 4% withdrawals safe, as the money may run out too quickly. On the other side, many people intimidated by current market conditions turn to cash and bonds for security. However, they don’t realize that assets need to be earning more than the inflation rate to keep from diminishing purchasing power. Money held in cash, even with modest inflation of 3% a year, loses half of its value in about 25 years. True security can’t be reached without creating room for at least modest growth.
How to Invest for Lifetime Income
If the stock market is too risky and cash cannot combat inflation, what can a divorcee with limited resources do to ensure a steady income for the remainder of his or her life? There is no single investment product that can generate a secure, guaranteed, inflation-protected income in current market conditions. In order to stay ahead of inflation without risking principal in the stock market, a combination of investments is required. There are a number of relatively secure sources of fixed income that can be used to help create a cash flow that divorcees may be able to depend on for the rest of their lives.
A successful investment strategy to generate lifetime income will split retirement into three time-spans:
- short-term (0-5 years),
- medium-term (5-15 years), and
- long-term (15+ years).
Depending on the time period, money should be invested differently to fund that portion of retirement.
Short-Term: CDs1 and Fixed Annuities
Immediate retirement needs should be funded with lower risk investments such as certificates of deposit (CDs) and fixed annuities. When interest rates are high, a CD “ladder” with staggered maturities may be appropriate. However, when interest rates are low, CDs don’t earn very much and a 5-year immediate payout annuity may be a better value.
Money designated to be used 5-15 years out can be invested differently than short-term funds since it is not immediately needed. One option is a bond ladder because if you own an individual bond, you’re faced with reinvestment risk when it matures. Laddering maturities (i.e., owning multiple bonds that mature at regular, staggered intervals) can help you deal with the uncertainties caused by fluctuation in interest rates.
To adopt a laddering strategy, you can either make an initial purchase of multiple bonds with different maturities or buy bonds periodically over time. For example, you could buy a bond every year, each time choosing a maturity date that’s different from your existing bonds. Alternatively, you could divide an initial sum of money and buy several bonds at once, with different maturities. The overall yield of your portfolio would likely be greater than if all your bonds were short-term.
This strategy also involves less risk than if all your bonds were long-term. There are no guarantees that laddering will increase your income, of course. However, having a ladder of short-, intermediate-, and long-term bonds provides you with liquidity as bonds periodically come due and the principal is paid. That gives you greater flexibility to make choices that you feel will take advantage of changing interest rates and increase your return.
Long-Term: Bonds and Stocks2
Longer term investments allow for more risk because if values go down, there is often enough time for them to recover since most market downturns resolve within ten years. Even stocks can be included in this portion of the investment portfolio based on their long-term returns. Large-cap stocks such as those found in the S&P 500 are often stable enough to gain over long periods of time. Since 1930, the S&P 500 has only had negative returns in two decades, 1930-1939 and 2000-2009, and each time was less than a 1% loss. The overall average return from 1930-2013 has been 9.7%.
Only a portion of the long-term portfolio should be invested in stocks to limit exposure and that portion should be invested conservatively. Risky stocks should be avoided since protecting assets is more important than chasing gains for a divorcee with a limited nest egg that must last a lifetime.
By approaching retirement with a view of multiple time periods each calling for different investment strategies, divorcees can convert assets into income without putting all of their assets at high levels of risk. Following a structured and disciplined approach may provide divorcees with more confidence and freedom from financial stress as they enjoy their retirement.
Sherry Campbell is a Certified Divorce Financial Analyst (CDFA®) and Certified Financial Planner (CFP®) with Hutchinson Family Offices, an independent concierge wealth management firm serving a select number of high-net-worth families. Hutchinson Family Offices specialize in divorce consulting, with their Marital Asset Protection Program™ (MAPP), which is designed to make the divorce settlement process more efficient and less costly. www.HutchinsonFamilyOffice.com.
Securities and Advisory Services offered through The Strategic Financial Alliance, Inc. (SFA). Member FINRA & SIPC. SFA is otherwise unaffiliated with Hutchinson Family Offices.
Ensuring Settlement Offers Work for Your Clients
With financial modeling during the divorce process, the client understands what they got and why they got it and has a financial roadmap for their life post-divorce.
1 Bank CDs are insured by the Federal Deposit Insurance Corporation and offer a fixed rate of return, whereas both the principal and yield of investment securities will fluctuate with changes in market conditions. Investments offering the potential for higher rates of return also involve a higher degree of risk. Rates of return will vary over time, particularly for long-term investments. Your actual results will vary.
2 Stocks have historically outperformed other asset classes over the long term, but tend to fluctuate more dramatically over the short term. Bonds are affected by changes in interest rates and the creditworthiness of their issuers. Bonds are particularly sensitive to interest rate movements. Therefore, bond prices and thus the share price of funds that invest in bonds, generally move in the opposite direction from interest rates. Investments seeking to achieve higher returns also involve a higher degree of risk. The return and principal value of stocks fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. Past performance does not guarantee future results.