One of the most important educational services that my firm provides is to help the average person understand what really works and what doesn't in investing. The financial services world is full of folks selling their brand of snake oil. It's hyped incredibly - so well that the salespersons selling it are completely convinced themselves.
Retirement income is one of these areas. It is of great concern because obviously retired people want a steady steam of income they can rely upon. Interest rates have been near historical lows for a long time. Because of the barrage of advertising and salespersons that call upon them, they are convinced they need the right product that comes with an income stream like a bond mutual fund, dividend paying stock mutual fund or an annuity. You see/hear advertisements all the time about people seeking safe streams of income for retirement.
First things first - before you get to the solution, you need to know your destination, starting point and your motivations for arriving there. Then you can develop an overall plan/strategy congruent with your values, which hopefully has been developed with at least one expert involved. We use three experts - our firm, an independent CFP (certified financial planner) and your own CPA. We make sure that they advice offered is top notch, so you can just focus on implementation of the advice.
So while I address some of these myths below - it's important to understand that my firm advocates the steps above first.
The best way to generate income over time is through stock dividends, stock capital gains, bond dividends and bond capital gains. A globally diversified portfolio generating diversified income streams. Further, a retiree should have 2-5 years of income in "cash equivalents" like a CD or bond ladder that you can count on. If a retiree already hold annuities, each should be analyzed separately. Those deemed "good" by the CFP should be kept and treated as part of the bond holdings. Some may be better off liquidated. All of these decisions must be made in the overall context of goals and financial projections. Note that a secondary benefit of the diversified stream is that most of the time capital gains are taxed at a lower rate.
Myths & Mistakes
1) Any strategy based on one particular "income generator" lacks diversification which is inherently dangerous. Lack of diversification is very dangerous and these strategies usually fail to keep up with inflation. Income generators relied upon include:
2) Dividend paying stocks - see Larry Swedroe's recent article here. There overall return is less than non-dividend paying stocks. The dividends are not guaranteed.
3) High yield bonds - very risky. Unlike stocks - risk taken in bonds is not returned nearly as well as it is in stocks.
4) Annuities: Two big problems with annuities: 1) they are "opaque" products - you can't see behind the curtain. They are very complex contracts with pages of fine print and 2) the salespersons that sell them earn a large immediate commission (several years worth of our fees) - so there is a very strong motivation to sell them. They are so complex that our independent CFP (trained as an actuary) often has to call the issuer and ask about 30 questions to nail down the important attributes. In certain circumstances they're fine. We run into people holding "old" annuities that guarantee 4% or 5% income - they are fantastic in our current low interest rate environment as a bond-equivalent with substantial guaranteed yield. If someone has "more retirement assets than they need" (very rare) and are also afraid of the stock market, then annuities can be a way to have a steady income (low guaranteed return) - while avoiding the market - and those with more assets than they need can afford the lower long term returns offered by annuities.
5) Failure to Plan for Long Term Care: One other important warning about retirement planning. Planning for long term care. Include that in your planning - the money, the oversight and moral support. It is VERY costly - it's emotionally and physically draining even if you have the money for help inside or outside the home. If your retirement planning is on track - but no extra left over - then a reverse mortgage might make sense to "self fund future long term care expenses". The lump sum proceeds are placed into a conservative portfolio. There are many advantages to a reverse mortgage that most folks are not aware of.
6) Social Security: Sure social security payments are not huge - but they are not to be ignored. There are some very important strategic decisions to be made with regards to social security that can result in receiving in receive as much as $500,000 more during retirement. Be very sure that your planner incorporates this planning!