Some retirees put all their
money into bonds, only to
suffer from the impact of
years of inflation. If you
get a 4% return and
inflation is 3% annually,
your real return is only
about 1% — not counting
any fees or taxes. Retiring
is no reason to turn your
back on growth-oriented
investments, though they
may involve greater
volatility, and past
Asset allocation is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.
Before investing in a
mutual fund, carefully
consider the investment
charges, and expenses
of the fund, which are
contained in the
from the fund. Read the
before investing. Also, remember that diversification alone doesn't guarantee a profit or protect against the possibility of loss.
Retirement Income Investing: Beyond Annuities
One of the challenges of investing during retirement is providing
for annual income while balancing that need with other
considerations, such as liquidity, how long you need your
funds to last, your risk tolerance, and anticipated rates of return
for various types of investments. Annuities may be seen
as a full or partial solution, since they can offer stable income
or guaranteed lifetime payments (subject to the financial strength and claims-paying
ability of the issuer). However, they're not right for everyone.
A well-thought-out asset allocation in retirement is essential. While income
investments alone are unlikely to meet all your needs, it's important to
understand some of the most common non-annuity investments that can provide
income as part of your overall investment strategy.
Bonds: retirement's traditional backbone
A bond portfolio can help you address investment goals in multiple ways. Buying
individual bonds (which are essentially IOUs) at their face values and holding
them to maturity can provide a predictable income stream and the assurance that
you'll receive the principal when the bond
matures unless a bond issuer defaults. (Bear in mind that if a bond is callable, it may be redeemed early, and
you would have to replace that income.) You also can buy bonds through mutual
funds and exchange-traded funds (ETFs). Bond funds are subject to the same inflation, interest rate, and credit risks associated with their underlying bonds. Depending on your circumstances, funds
may provide greater diversification at a lower cost than individual bonds.
However, a bond fund has no specific maturity date and therefore behaves
differently from an individual bond, though like an individual bond its price
typically moves in the opposite direction from interest rates, which can adversely affect its performance.
Consider the issuer
Bonds are available from many types of issuers, including corporations, the U.S.
Treasury, local and state governments, governmental agencies, and foreign
governments. Each type is taxed differently. For example, the income from
Treasury securities (unlike corporate bonds) is exempt from state and local
taxes but not from federal taxes. U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest. The principal value of Treasury securities fluctuates with market conditions. If not held to maturity, they could be worth more or less than the original amount paid.
Bonds issued by state and local governments, commonly called municipal bonds or
munis, are just the opposite. Often a staple for retirees in a high tax bracket,
munis generally are exempt from federal income tax (though specific issues may
be taxable), but may be subject to state or local taxes and the alternative minimum tax. Largely because of
that tax advantage, a tax-free bond typically yields less than a corporate bond
with the same maturity. You'll need to compare a muni's tax-equivalent yield to
know whether it makes sense on an after-tax basis.
Think about bond maturities
Bond prices can drop when interest rates and/or inflation rise, because their
fixed income will buy less over time. Inflation affects prices of long-term
bonds — those with maturities of 10 or more years — the most. One way to keep a
bond portfolio flexible is to use so-called laddering: buying bonds with various
maturities. As each matures, its proceeds can be reinvested. If bond yields are
up, you benefit from higher rates; if yields are down, you have the option of
choosing a different maturity or investment.
Certificates of deposit/savings accounts
Certificates of deposit (CDs), which offer a fixed interest rate for a specific
time period, usually pay higher interest than a regular savings account, and you
typically can have interest paid at regularly scheduled intervals. A CD can be
rolled over to a new CD or another investment when it matures, though you may
not get the same interest rate, and you'll pay a penalty if you cash it in
early. A high-yield savings account also pays interest, and, like a CD, is
FDIC insured up to $250,000 per depositor per insured institution.
Stocks offering dividends
Dividend-paying stocks, as well as mutual funds and ETFs that
invest in them, also can provide income. Because dividends on
common stock are subject to the company's earnings, which are influenced by economic, market, and political events, and
a decision by its board of directors each quarter, dividends are typically not guaranteed and could be changed or eliminated.
However, dividends on preferred stock are different; the rate is fixed and
they're paid before any dividend is available for common stockholders. That
fixed payment means that prices of preferred stocks tend to behave somewhat like
bonds. Preferred shares usually pay a higher dividend rate than common shares,
and though most preferred stockholders do not have voting rights, their claims
on the company's assets will be satisfied before those of common stockholders if
the company has financial difficulties. However, a company is often permitted to
call in preferred shares at a predetermined future date, and preferred
stockholders do not participate in a company's growth as fully as common
Some investments are designed to act as a conduit for income from underlying
assets. For example, mortgage-related securities represent an ownership interest
in mortgage loans made by financial institutions. The most basic of these, known
as pass-throughs, represent a direct ownership interest in a trust that consists
of a pool of mortgages. Examples of pass-throughs include securities issued by
the Government National Mortgage Association, the Federal Home Loan Mortgage
Corporation, and the Federal National Mortgage Association.
Automated inflation fighting
Some investments are designed to fight inflation for you. Treasury
Inflation-Protected Securities (TIPS) pay a slightly lower fixed interest rate
than regular Treasuries. However, your principal is automatically adjusted twice
a year to match changes in the Consumer Price Index (CPI). Those adjusted
amounts are used to calculate your interest payments.
The inflation adjustment means that if you hold a TIPS until it matures, your
repaid principal will likely be higher than when you bought it (the government
guarantees it will not be less). However, you can still lose money if you sell a
TIPS before maturity. Inflation rates change, and other interest rates can
affect the value of a TIPS. If inflation is lower than expected, the total
return on a TIPS could actually be less than that of a comparable non-indexed
Treasury. Also, federal taxes on the interest and increases in your principal
are owed yearly even though additions to principal aren't paid until a TIPS
matures. Inflation-linked CDs function much like TIPS, but you'll generally owe
federal, state, and local taxes each year.
Some mutual funds are managed with an eye toward inflation. A mutual fund that
invests in inflation-protected securities pays out not only the interest but
also any annual inflation adjustments, which are taxable each year as short-term
capital gains. Some funds target inflation by mixing TIPS with floating rate
loans, commodity-linked notes, real estate-related investments, stocks, and
Some mutual funds are designed to provide an income stream from year to year.
Available as part of a series, each fund designates a percentage of your assets
to be distributed each year as scheduled payments, usually monthly or quarterly.
Some funds are designed to last over a specific time period and plan to
distribute all your assets by the end of that time; others focus on capital
preservation, make payments only from earnings, and have no end date. You may
withdraw money at any time from a distribution fund; however, that may reduce
future returns. Also, payments may vary, and there is no guarantee a fund will
achieve the desired return.
New ways to help you translate savings into income are constantly being created.
These are only a few of the many possibilities, and there's more to understand