There are two major categories of investment strategy. The first is what most people associate with the pursuit of wealth. In the investment world, this is called the growth strategy. When your goal in investing is to grow your portfolio and net worth, you are looking for the kind of vehicles likely to grow in value.
When you are looking for income, your goals shift and your focus also changes. Income vehicles aren’t necessarily those likely to grow the fastest. They are ones likely to generate steady and reliable income over a long period of time. Annuities, bonds and dividend-heavy stocks are common in these kinds of portfolios.
First, determine what your investment goal is. If your investment goal is to generate income for the purposes of providing for your retirement, it is important you understand the best way to accomplish this. You must combine savings, investing and tax advantages into a portfolio. Your goal is to provide the maximum income with minimum risk.
The ideal situation for someone getting ready to retire is to gradually shift their focus away from growth and into income. By now most investors have heard of the 80/20 rule. This refers t the proper proportions of each kind of investment. Early in life, your best advice is to put 80% of your portfolio into growth issues like small cap stocks. As you progress through your career, you move a larger and larger percentage of your growth investments into income. By the time you reach retirement age, the ratio has flipped. Instead of 80% growth, now you have 80% income.
If you followed good advice during your investing career, you likely engaged in a practice called “dollar cost averaging.” This is where you purchased issues at varying prices as a hedge against risking a large investment all at once. When you approach retirement, you begin converting growth shares and savings to income investments. It is often a good idea to sell those shares with the smallest margin between cost basis and selling price. Not only will this reduce your tax liability, but it will also preserve your most successful positions as part of your remaining growth engine.
While they may not have the kinds of outsized interest rates as commercial paper or what the market refers to as “junk” bonds, municipal bonds have one very important feature. The fact is, their income is often tax free. When you loan money to the government, which is what you are doing when you buy a municipal bond, one of the government’s rewards is to pay you interest without taxing it. If your income were taxed, those bonds would likely have rather poor income potential when compared with other options. In order to compete effectively, municipal bond interest is untaxed in order to incentivize investors. Taking advantage of this is one way to reduce your tax burden and secure future income.
Even though they are subject to taxes on dividend income, some stocks are almost as reliable as bonds when it comes to regular income. Don’t overlook these kinds of investments too quickly. They may provide you with growth potential in addition to regular income. There are entire market indexes devoted to dividend stocks. Try to find shares that have a long history of dividend payouts, as those will be less likely to change policy in the near-to-medium-term.