I recently met with a prosperous couple, each well-employed and contemplating retirement. They have children that are grown, a house that is paid for, a combined income around $150,000, and employer 401(k)s exceeding $1,000,000. They don’t have an extravagant lifestyle, but see the best years of their lives in plain view. The last thing they want to do is speculate in the stock market, because the stock portions of their 401(k)s have languished and the economic news is frightening. Principle preservation is their primary concern. A safe portfolio of bond mutual funds and annuities sounds right to them.

This financial plan resonates with just about everyone who is retired or thinking about it. A reasonable rate of return with principle protection is doable and worry-free, right? Well, as in most circumstances, perception and reality often take different paths. First, let’s do the math and compare their working income to their potential retirement income at various rates of return:

As this chart illustrates, our soon-to-be-retired friends need a 10% return to replicate their current income of $150,000—and this doesn’t even consider the future loss of purchasing power as a result of normal levels of inflation. Now the question becomes, how can they realize sufficient income through their investments, and will the “normal” route of bond investing solve the problem? Or perhaps one of these “guaranteed” annuities being offered? Sadly, these kinds of returns cannot be realized through the traditional “safe” route of bonds. Nor are annuities really a sure thing.

Long-term U.S. Treasury Bonds today yield a mere 2.8%, and if interest rates rise only 2% at any point in the future, the value of the bonds will depreciate meaningfully. Shorter-term bonds mitigate this risk, but unfortunately yield even less. Junk bond funds and assorted other investments can pay a significant “spread” over Treasuries, but such securities are typically issued by non-investment grade borrowers and can be fraught with default risk. In this environment, a “laddered” portfolio of a variety of relatively short- to mid-term maturities issued by strong municipalities or A-rated corporations can provide meaningful liquidity if one needs the money. However, bonds alone can’t meet the income needs of many.

This dynamic—looking at severely reduced income with 2% bonds—leads many to pine for 7% yields, and they go to great lengths to get there, whether it be through junk bonds or annuities. Annuities may “guarantee” returns of 7% a year for ten years- but we have to remember that annuities are just an insurance product. These instruments sound great to investors who remember ’08 and ’09, but we fielded many calls from people who had invested in “guaranteed” annuities—and lost more sleep over the threat of losing all of their annuity investment as the insurance companies almost went under. These “guarantees” are only as good when the insurance companies underwriting them.

Instead, we look to blue chip stocks for a “higher octane” return, purchased wisely over time at prices that mitigate the risk of depreciation. We refer to companies such as Procter and Gamble, Johnson and Johnson, and Exxon Mobil as “trophy” stocks which have appreciated over the years well above client thresholds. Today, these stocks yield above the market average and have consistent histories of increasing their dividends well above the rate of inflation. A well-allocated portfolio of stocks and bonds can provide a means of liquidity if we need to spend the money, but allow our retired clients a manageable retirement.