Author: Matthew Frankel, CFP | January 07, 2019
Investing in retirement
When you’re retired, you’re probably focused on different priorities with your investments than you were when you were still working. Instead of focusing on growth, retirees’ investment objectives tend to gravitate toward income and stability.
However, far too many retirees simply use their nest egg to buy an annuity. While this can certainly create a worry-free stream of income, it is rarely the most financially-beneficial option.
There are plenty of excellent investment options available to retirees, ranging from risk-free income generators to hands-on investments that can generate some serious returns. Here are 11 examples of savvy investments retirees can make to put their nest egg to work.
This is one of the more obvious choices when it comes to income-generating investments for retirees, but it’s still important to mention.
Stocks with reliable, above-average dividends not only tend to hold up better than their non-dividend counterparts during recessions and other tough times, but they also tend to deliver long-term returns that are as good or even better.
If you want to invest in individual stocks in your brokerage account, the Dividend Aristocrats are a good place to start. These are stocks that are S&P 500 components that have increased their dividends for at least 25 consecutive years. And, if you’d rather not deal with individual stocks, one of my favorite ways retirees can get dividend exposure is through the Vanguard High Dividend Yield ETF (NYSEMKT: VYM), which yields over 3% and invests in some of the most rock-solid dividend stocks in the market.
You may be surprised to hear it, but billionaire investor Warren Buffett has repeatedly called index funds the single best investment most Americans can make.
An index fund is simply a passive investment vehicle designed to replicate the performance of a certain benchmark index. For example, a S&P 500 index fund would invest in all 500 stocks that make up that index.
It’s an important principle of asset allocation that retirees should still maintain some exposure to stocks. Using passive index funds to do this limits your exposure to any single stock’s performance, and should come with minimal fees, so most of your investment returns stay in your pocket.
Peer-to-peer, or P2P, lending is a relatively new form of income investment. Essentially, instead of loaning money to customers directly, peer-to-peer marketplaces crowdsource loan capital from investors, who have the opportunity to profit as the loan is repaid.LendingClub is a great example of a peer-to-peer lender. Investors can choose to invest as little as $25 in each individual loan in order to diversify their holdings and can also choose to finance loans to borrowers with top-notch credit ratings or to take a little more risk with subprime borrowers. LendingClub claims that 99% of investors who spread their money out properly among 100 or more loans earn positive returns, and that the average “A” credit loan generates annualized returns of about 4.8%.
This is about as risk free as it gets when it comes to income investments. Treasury securities are backed by the full faith and credit of the U.S. government. And, just to clarify the terminology:
- Treasury bills have maturities of less than two
- Treasury notes have maturities ranging from two
to 10 years.
- Treasury bonds have maturity lengths of more
than 10 years.
One caveat. While your income is virtually risk free, the value of Treasury securities (especially the longer-maturity ones) can vary significantly over time in response to market interest rate fluctuations. Investors can buy Treasury securities directly from the government at www.TreasuryDirect.com.
This may sound like a terrible option at first -- after all, the national average savings rate is a paltry 0.09% as of this writing.
However, there are many reputable institutions that offer online-based savings account products that pay significantly above-average rates. These banks don’t have to deal with the costs associated with physical branches and can pass the savings along to consumers in the form of more interest.Just to name a couple of excellent examples of online savings accounts, Marcus by Goldman Sachs currently offers a yield of 2.25% on its online savings account, and Synchrony Bank offers 2.20%. Both are FDIC-insured for up to $250,000.
A close cousin of savings accounts, CDs (short for certificate of deposits) can be an excellent way to get even more risk-free income. The catch is that you have to agree to leave your money on deposit for a certain length of time (generally, CD maturities vary from about 90 days to six years). For this reason, CDs are also referred to as time deposits.
Marcus by Goldman Sachs currently offers a 2.75% APY on a 12-month CD and a 3.15% APY for customers who agree to a six-year maturity, just to name an example from one financial institution. Just as with savings accounts, online-based banks tend to have the best CD rates.
Tax-free municipal bonds
Municipal bond income is generally exempt from federal income tax and may also be excluded from state taxes.
For this reason, municipal bonds can be an excellent choice for high-income retirees. Think of it this way -- if you earn a 4% yield from a corporate bond and are in the 37% tax bracket, your yield is effectively cut to just 2.52%. So, a municipal bond with a 3% yield would actually be a better investment choice. Of course, this is a simplified example, but the point is that a seemingly lower yield from a municipal bond can be a better investment than it may seem.
TIPS stands for Treasury Inflation-Protected Securities, and can be a great way for retirees to protect their nest egg from the damaging effects of higher-than-expected inflation.Here’s how it works. TIPS pay interest twice a year at a fixed rate. However, the principal of a TIPS investment adjusts upward over time to keep up with inflation. The fixed interest rate is applied to the adjusted principal amount, so the dollar amount of interest payments investors get will rise along with inflation. At maturity, the adjusted principal amount is paid to the investor.
Generally speaking, I’m not a big fan of annuities. Many annuity products have high fees, are difficult to understand, and quite frankly are not as good as some of the other investment choices available. One possible exception is a deferred-income annuity, which I often refer to as insurance against longevity.
Here’s how it works. You give a company a lump sum of money today in exchange for a perpetual stream of income that starts at a later date. For example, you may give an annuity provider money when you turn 60 for an income stream that begins when you’re 75. If you’re worried about the possibility of outliving your savings during your retirement, a deferred-income annuity could be a smart move.
Real estate investment trusts, or REITs, which invest in commercial real estate assets, can be fantastic ways for retirees to get both income and growth. REITs are required to distribute at least 90% of their taxable income to investors, which often results in above-average dividends. And, because the value of the underlying properties tends to increase over time, REIT stocks can grow in value as well, producing some pretty impressive total returns.
As an example, Realty Income Corporation (NYSE: O) invests in freestanding retail properties and pays a 4.3% dividend yield in monthly installments. The company has made 581 consecutive dividend payments, and thanks to strong performance from its portfolio, has delivered impressive 15.9% annualized total returns since its 1994 NYSE listing.
Just like with REITs, investing in a rental property can produce excellent returns through a combination of rental income and gradual increases in property values.
To be clear, being a landlord isn’t for everyone. For starters, you’ll have to deal with the uncertainties of maintenance costs, property taxes, and insurance. And, unless you want to pay a property management company to do it for you, you’ll need to find and manage your tenants, which can be quite a task.
However, an investment property can have a double benefit for retirees. Not only can it be a great investment choice, but it can also give you a productive activity to help occupy your time.
Plenty of good choices
These are some excellent options for retirees, and this isn’t necessarily an exhaustive list. The bottom line is that it’s certainly possible to create a low-risk investment portfolio after you retire that generates steady income and still has lots of long-term growth potential.