The Benefits of Investing for Income in Retirement
If you’re planning to retire soon, you’ll need to plan for how you’ll support yourself once you leave the workforce. In order to live comfortably and maintain the lifestyle you want, you might need to tap into your retirement accounts — even if that means pulling from your investments with growth potential in order to live off of income from interest or dividends.
The benefits of investing for income in retirement include living on money that won’t lose value over time, relying on passive income versus depending on the success of your own business and not having to work again once you’ve established this income stream.
You need a long-term strategy
We all know that the number one goal of retirement is to maintain the lifestyle you want without having to work. But how do you do that? With a long-term strategy. One way to make sure you're on track with your long-term strategy is by investing for income in retirement.
Doing so can help make sure your money lasts as long as possible and helps to provide a steady stream of cash flow that can help pay the bills and support your lifestyle year after year, even if the markets take a downturn.
When investing for income in retirement, there are two primary ways it can be done: through dividends or through interest payments.
Both have their own benefits and drawbacks, but by making an informed decision, retirees can find what works best for them.
Fixed income vs. alternatives
Fixed income investments may not sound very exciting. But, they are steady and predictable. You know exactly how much income you will receive each month or year without worrying about the investment's value going up or down.
That is why many investors rely on fixed income investments to meet their retirement goals and provide reliable monthly cash flow.
In contrast, alternative investments such as stocks, bonds, and ETFs are less stable because their values go up and down with the market. They may be worth more now than when you bought them, but they could also be worth less tomorrow - or even by the time you read this sentence!
Plus, they may not generate a lot of regular monthly income when you need it most in retirement.
Bonds can be volatile but less risky than stocks
Bonds are a great way to generate a steady stream of income, which is why they're often the first investment people choose when they retire. The downside to bonds is that they're less volatile than stocks, but more risky than cash equivalents like money market funds and CDs.
Your best bet is to diversify your portfolio by investing in different types of securities. A good rule of thumb is that you should have about 60% stocks and 40% bonds if you're looking for safety with a reasonable return.
Look at yield to maturity and duration
To generate income, bonds can be used to purchase those that pay a periodic interest or coupon. You may also choose to invest in certificates of deposit (CDs) for their higher yield and longer duration.
The ability to withdraw money from CDs before maturity is one disadvantage. Be sure you have the funds available if this becomes necessary.
Diversification is key
Investing for income is different than investing to grow your money. When you invest with the goal of growing your portfolio, you're trying to achieve higher returns by taking on more risk.
If you're not comfortable with that level of risk, then it may be better to seek out more conservative investments and focus on generating some steady income streams.
Your main investment options are stocks and bonds, but there are a few other things worth considering, like real estate and peer-to-peer lending platforms. And if your retirement horizon is long enough, it can make sense to take on some additional risk with the hope that eventually it will pay off big time.
Keep your fees low
When investing for income in retirement, keep your fees low to minimize the drag on your returns. This will help you maximize the power of compounding over time. There are a few ways to do this. First, consider index funds or ETFs that track a broad market index like the S&P 500 or FTSE100.
These investments are typically cheap because they're passively managed and don't require high-cost research analysts. Second, avoid actively managed mutual funds with hefty expense ratios that eat away at your nest egg's gains.
Rebalance your portfolio regularly
One way to earn income from your investments is by rebalancing them. Rebalancing is a process that tries to maintain an asset allocation which is consistent with your investment goals and risk tolerance.
The stock market often goes up and down, creating gaps between the amount of money you want to allocate to stocks and the amount you are actually allocating. By selling some of your stocks (or other assets) you can then use that money to buy more bonds or cash, bringing the allocation back in line with what you originally wanted it to be.
This helps maintain a balanced portfolio and also provides a way for investors who need income generated from their investments to produce it without having sell all their holdings.
Build your cash reserve first
I recommend building your cash reserve first. When you invest for income, you want to make sure that you have enough money to live on in case something happens. Your emergency fund should be at least six months of living expenses and it should be accessible so that it can be used when an unexpected need arises.
If you are younger than 50 and have not reached the end of your working life, then I recommend investing at least half of your retirement savings in stocks and the other half into bonds. Bonds provide more stable returns, but with a low-risk appetite. If you are retired or approaching retirement, then I recommend investing 100% into stocks.