Something people are very good at is taking an experience in one area and applying it to another. You drive a go kart as a kid, and much of what you learn is applicable to driving a car. Unfortunately we have a tendency to do it an areas where it’s not appropriate. One of those is with the concept of ‘principal’.
You borrow money, and one of the things you get is a statement of principal and interest. Some of what you pay is principal, and some is interest. If you don’t pay any principal, the loan balance never goes down. So people turn this around and say “If I invest and only spend the interest, my ‘principal’ will remain intact”. Unfortunately, when investing, the concept of principal doesn’t actually apply. Here is an example.
Let’s say an investor has $100,000 to invest, and wants to earn 5% on the money and plans to withdraw only the interest and not the principal, once a year. At the end of the first year before he withdraws the money he’ll have $105,000. So how much principal does he have? Answer, $105,000. If he bought stocks that went up 5% during the year and earned no interest, the answer would be the same, $105,000, not $100,000. Any money he has is his principal at all times.
This may seem like I’m splitting hairs and making a big deal about the definition of a word. But it’s an important idea. When people say they don’t want to spend the principal, what they really mean is that they want the withdrawals to be indefinitely sustainable. But in the above example, stocks or bonds would serve just as well. Stocks flutuate more, no question. But he can sell appreciate shares to withdraw funds just as easily as he can spend the interest on his CDs or bond dividends. Also, if he buys high yield/high risk bonds, the interest paid will not be sustainable. Somewhere along the line some of those bonds will have problems. In that case, the investor will have to spend less than the dividends paid if he wants it to be fully sustainable.
Truthfully, to be fully sustainable inflation must also be taken into account. If the account is $100,000 to start, it needs to grow every year to maintain the ‘principal’.
There is nothing wrong with spending down some assets as we age. Just be aware that every nickel someone owns is their principal.