Many people dream of retiring at a relatively young age and then living off the income from their investments.
For many retirees, shares form the backbone of their retirement portfolios.
In the long run, stocks can be expected to offer reasonably high returns and can offer above-inflation income opportunities as well.
However, is the idea that an investor can retire and live off their shares simply unrealistic?
Or, is it possible to own a diverse range of stocks and lead a comfortable retirement?
Let’s dig deeper to find out.
As mentioned, the returns on shares generally exceeds the returns on all other mainstream assets in the long run.
Holding assets such as cash, bonds and even property is likely to garner a lower return than if the cash had been used to buy a diverse range of strong companies.
Therefore, in the long run, it seems logical to invest your entire retirement portfolio in shares.
After all, doing so can allow your money to compound to a significant sum and potentially offer more spending power in the long run through increasing dividends.
The main problem with shares is their volatility.
During major events such as downturns, share prices can fluctuate wildly as businesses succumb to weak demand and report falling profits or even losses.
Investing in shares may seem like a sound idea to most people.
The reality, though, is that bear markets will inevitably crop up at some juncture. We have already witnessed one in March last year.
No stock market has ever risen in a straight line, so if you own an all-shares investment portfolio, you will, at some point, suffer a steep but temporary fall in the value of your portfolio.
Of course, the same could be said for most assets, but perhaps the difference with shares is that they are more volatile than other assets.
For example, bond prices do not usually fluctuate to the same extent as share prices.
Similarly, property valuations tend to move much more gradually than share prices, while the real value of cash is often only eroded gradually by inflation.
This high volatility can present problems for retirees as most seek a reliable, stable and consistent income with which to enjoy their retirement.
If the value of their portfolio is constantly rising and falling dramatically, it may lead to sleepless nights amid the worry that there will be a fall in returns in the short run.
Due to the volatility of shares, it may be prudent for retirees to keep a portion of their investment portfolio in lower risk, less volatile assets such as short-term bonds.
They may offer lower returns than shares, but they may also provide more stability and greater liquidity.
By doing so, it ensures that a retiree has sufficient cash with which to survive in the short run in case share prices and dividends decline.
And in the long run, they are still likely to benefit significantly from the capital growth and income return which shares have historically provided.
As such, the idea of living off shares in retirement is a realistic strategy to adopt. However, a consideration for short-term cash flow must also be factored in.
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Disclaimer: Royston Yang does not own shares in any of the companies mentioned.