During the majority of your investing life, you'll be most concerned with getting your investments to grow as much as possible. But there comes a time -- usually as you enter or approach retirement -- when you actually need to start using all the money you've saved. That's when it becomes important to find ways to make your portfolio generate the income you need.
During times like these, getting enough income can present quite a challenge. Yet there are a number of strategies you can use to get the cash you need, and though each has its pros and cons, the right combination can work wonders for your retirement years.
Traditional income-generators
When confronted with the need to choose income-producing investments, many retirees immediately gravitate to ultra-conservative investments like bank CDs and savings accounts. With the full backing of the FDIC, bank products carry no default risk, even if your bank happens to fail.
But right now, you give up a lot for that level of safety. Even some fairly high-yielding banks, including Discover Financial's (NYSE:DFS) Discover Bank and the banking unit of American Express (NYSE:AXP), pay 2% or less on CDs even if you're willing to lock up your money for a full year. Even five-year CDs only pay a bit more than 3% right now.
Moreover, it's even harder to find good fixed-income alternatives to bank CDs. Treasury bonds earn less interest at every maturity, so while they share the same level of creditworthiness, they're not a good answer if you need more income.
Raising your risk level
If you're willing to take on more risk, then you can find investments with more attractive payouts than bank CDs.
Corporate bonds, for instance, have gotten a lot of attention lately. After having taken a severe hit during the financial crisis last year, corporate bonds have performed extremely well this year, and they still offer somewhat attractive yields. For instance, among companies with investment-grade credit risk, CVS Caremark (NYSE:CVS) offers a 30-year bond yielding over 6%, while International Paper (NYSE:IP) has a shorter-maturity bond offering a 6% yield on bonds maturing in 2021. Issuers with a higher risk of default, such as Ford Motor (NYSE:F) and Teck Resources, have yields that are even higher compared to others with similar maturities.
Another alternative for income-seeking investors is preferred stock. This investment shares characteristics of both bonds and stocks; preferred stock tends to pay higher dividends than regular common stock, but it typically doesn't have as much growth potential. Many companies have preferred stock available, including Annaly Capital Management (NYSE:NLY) and Bank of America (NYSE:BAC).
And, of course, you can always invest in regular dividend-paying stocks. Although yields have come down significantly during the stock market's rally, several stocks still offer payouts well above the rates you'll find on most bonds.
The thing to remember about all of these investments is that they carry certain risks that bank CDs and Treasuries don't. Unlike a bank CD, corporate bonds and preferred and common stock all have a substantial risk of losing principal. Just last year, investments in all three of these categories suffered fairly big losses -- losses that CD investors avoided entirely.
Locking in income
In partiuclar, none of these investments addresses one primary concern that retirees have: how to sustain the income they receive. CDs and bonds have reinvestment risk, in that when a given CD or bond matures, the prevailing interest rates on new securities may have fallen, cutting your income. Similarly, stocks can always reduce or eliminate dividend payments, putting your income at risk.
Immediate annuities, however, can guarantee a certain payout for the rest of your life. Issued by insurance companies, immediate annuities have you pay a single premium in exchange for a fixed stream of monthly payments. How much you receive each month depends on how much you invest, as well as the payout options you choose. In many ways, immediate annuities resemble old-style pension payments that used to be commonplace for retirees to receive from their former employers.
None of these investments can address all of your needs and concerns by itself. However, a smart investment plan may use a combination of several or all of these investments, building a strategy that handles a variety of contingencies. Regardless of which you choose, you can rest assured that you'll figure out a way to get the income you need to have a secure retirement.
Retirement is your most important financial goal. Let Selena Maranjian help you keep your retirement from going up in smoke.
