I’m 60, prepping for retirement, and I have $1,200,000 saved. I want to live off dividend income 100% versus selling shares. Is this really less risky than a ‘total return’ approach?

Which is better? Let’s explore.

Living off of portfolio income alone

A 2024 Allianz Life survey found that 63% of Americans are more worried about running out of money than dying.

The nice thing about living on portfolio income in retirement is that you aren’t touching the principal, meaning it should, in theory, hold steady or grow rather than shrink.

But it takes a lot of principal to generate sufficient income to live on, especially when dividend yields are as low as they are today.

The average S&P 500 dividend yield is currently just 1.27%. Even if you assemble a portfolio of individual stocks with higher dividend yields, you may only be looking at 5%.

For a portfolio worth $1.2 million, that’s $60,000 in annual income, which may or may not be enough to maintain your lifestyle.

Of course, it’s not a good idea to keep your entire portfolio in stocks. A safer bet is to split your assets between stocks and bonds, which could produce a little under a 5% return. It is doable, but whether the income suffices depends on your income-related needs.

Keep in mind you’ll have Social Security benefits, as well. With the average retired worker collecting $1,978.77 a month in Social Security, you could be looking at $24,000 in benefits annually.

Combined with $60,000 a year income from your portfolio, that’s $84,000, which paints a different picture.

One big caveat: While living on your portfolio income allows you to preserve your principal to a degree, neither growth nor income is guaranteed.

Market volatility means your stocks could fall in value, eroding your principal. Stock dividends aren’t guaranteed the way bond interest and principal are guaranteed if you hold bonds to maturity.

The other risk of an income-only approach is that you could lose buying power over time as inflation drives living costs upward. If your portfolio holds steady at $60,000 a year, it may not cover your costs in a decade.

The “total return” approach

Another option is to live on income and principal from your portfolio — the “total return” approach — as you whittle down your principal while enjoying dividends.

This is a more flexible approach. You can sell principal assets and take advantage of market gains. As your portfolio grows, a total return approach gives you access to more annual income, making it easier to keep up with inflation.

Here’s how this might work. Say you have $1.2 million and you decide to follow the 4% rule, drawing down 4% of your principal annually to ensure your savings last 30 years. In your first year of retirement, you’d receive $48,000 of annual income. If inflation then rises 2% the next year, you’d withdraw $48,000 plus another 2%, or $960, for a total of $48,960.

As your portfolio gains value, you can keep adjusting your withdrawals for inflation, making it easier to keep up with the cost of living.

The 4% rule is just a guideline. There are other factors to consider as you determine your withdrawal rate: market conditions, your investment mix, and your life expectancy.