Historically, if you desired income, you purchased income investments such as bonds or preferred shares. However, the data suggests that stocks may be a better source of income. Although most stocks do not have very significant dividends (the average dividend on the S&P 500 stands at 1.28%), their appreciation over time can be used as a substantial source of income.
A study published in the AAII Journal (February 1998) indicated that a portfolio heavier in stocks provided a better chance of a retiree meeting their income needs than a portfolio of bonds.
For the period analyzed of 1926 to 1995, the data showed that if an investor wanted to draw 7% annually on their portfolio for 20 years after retiring, a 100% bond portfolio would have been successful in delivering the necessary income only 47% of the time. On the other hand, a portfolio of stocks would have been successful at delivering the required income 92% of the time.
If we look at the same data but only for the period since World War II, stocks show up even better than bonds as a retirement income source. Stocks would have been successful 100% of the time in producing a 7% annual income which bonds would have been successful only 42% of time.
The best part about this study is that it takes into account that stocks can be more volatile than bonds. The study accounted for the fact that a retiree would need to take their 7% income even in years when their portfolio was declining in value and thus tests these hypothetical portfolios under a real life scenario.
If you've been staying away from the stock market, worrying that it's "too high" and relying on income investments to supply your retirement income, this article suggests that you are taking the more financially risky path. I know that stocks seem more risky because many investors focus on the short term. But when you look at the long term as this article does, you can more clearly see that bonds have been the more risky income alternative as they have failed to deliver a 7% income more than half of the time.
If you'd like details on how to design a stock portfolio that has provided an investor's income needs comfortably at 8% annually for the past 25 years, please check off the attached coupon.