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Why You Need to Diversify Your Retirement Income

Most likely you're familiar with investment diversification -- the "don't put all your eggs in one basket" theory of investing. An important refinement of this theory is retirement income diversification. This strategy can protect your retirement income no matter what happens, since it's hard for most of us to accurately predict when high inflation or a recession will occur. As a result, you want to have different sources of retirement income that can withstand various types of economic challenges.

Here I follow up yesterday's post, Think Inflation Will Return? How to Protect Your Retirement, by elaborating on the concept of retirement income diversification. The table below summarizes why this is an important goal by rating how different sources of retirement income fare in various economic climates.

I realize this is a complicated chart, and there's no need to memorize it. But let me just make some general observations about it.

First, note that the only source of income that does well in all three economic scenarios is Social Security benefits. This is one reason why maximizing your Social Security income is a good strategy. Every other source of income does well in some climates but poorly in others.

Given that many people might need to work during their retirement years, it might make sense to include "wages" as a source of retirement income in the above chart. In this case, I'd rate wages as "good" in both normal times and in times of high inflation, since wages can be a reliable source of income. During a recession, wages are "good" only if you can get and keep a job. If that's the case, wage income ranks up there with Social Security as a source of income that does well in all economic climates, and is a good reason to keep your feet in the job market. But it's a risk to rely heavily on wage income if you're employed in a job or industry that's vulnerable to layoffs.

It's hard for most of us to accurately predict when the above economic climates will occur. Also, given how long you'll be retired, there's a good chance you'll experience all three types of economic environments during your lifetime. That's why it's a good idea to diversify your sources of retirement income.

The good news is, some financial decisions that you make can be modified to reflect changing economic conditions, such as your investment strategy and the amount you withdraw from your savings. Other decisions, however, can't be changed or are difficult to change, such as how to draw your pension, when to start Social Security benefits, and the purchase of an immediate annuity. That's why it's also a good idea to have some sources of income that can be modified along the way.

If you're interested in learning more about this topic, my book, Recession-Proof Your Retirement Years, explores in detail the concept of diversifying your retirement income so that you can survive economic downturns that are inevitable during the long period you hope to be retired.