The transition from saving to spending in retirement can raise a few questions. It’s a new frontier to move away from a steady paycheck to learning to live on what you’ve been accumulating over the years. An important piece is knowing how to invest your money to help with your income needs. Below are answers to know before you cross into retirement.
How Do I Approach My Retirement Portfolio?
As you near retirement, your prime earning and saving years will end. You’ll move into a time to hopefully enjoy life after working. And you’ll move from accumulation (saving as much as you can) to decumulation, when you begin to draw from your nest egg. The three tips below are for your retirement investments.
3 Investing Things to Consider for Retirement Income
1. Start with a retirement income plan.
2. Keep your portfolio invested with a mix of different asset types.
3. Rebalance periodically to generate the cash you need.
Which Investments Create Income?
Below is an overview of some income-producing investments. Look for ones that help produce regular income so you won’t need to return to work to cover expenses.
Bonds, individual or bundled in funds, are loans you give to governments, municipalities or corporations that then pay you back with regular interest. When a bond matures, you receive its face value. People buy bonds to receive the regular interest income they may produce. They also like the principal you receive when they mature.
Real Estate Investment Trusts (REITs) are mutual funds that combine real estate holdings (apartments, commercial structures, vacation properties, etc.). For a fee, professionals manage the properties, collect rent and pay expenses. You receive the remaining income.
Dividend income funds are a collection of stocks a fund manager oversees. The dividends you receive come from those paid out by the underlying stocks in the fund. Note that dividends can rise one year and fall the next.
Immediate or variable (with a lifetime income rider) annuities provide guaranteed income. They are a form of insurance rather than an investment (but still included here because they provide a stated income).
Keep in mind many of the vehicles above are investment products and not financial planning tools. Make sure you have a well-designed retirement income plan in place before you buy any financial product.
What Are the Risks to Consider With Bonds?
Bonds can be an important part of a retirement portfolio because they tend to be less risky than stocks. But they still hold risk. Generally, there are three risks to look at when you evaluate a bond.
Inflation risk. Most bond payments are fixed, but prices of the things you buy keep going up. Bond payments may not always keep up with inflation.
Credit risk. This risk relates to a bond issuer’s ability to make its payments on time or at all. Pay attention to issuers’ credit ratings before you buy.
Interest rate risk. Bond prices move in the opposite direction of interest rates. In other words, when rates rise, bond prices fall.
What to Know About Dividends Vs. Selling Shares?
You can transfer interest and dividends to a bank account first, and then sell your shares if needed. Note that with dividends you won’t receive a fixed amount each time. On the other hand, when you sell shares, the risk of a down market is a critical element. A big drop early in retirement can be particularly damaging and you could sell shares at lower values.
You’ll also want to consider tax implications of withdrawing income from your portfolio. For example, it typically makes sense to avoid selling shares purchased within the last 12 months to limit short-term capital-gains tax treatment.
Taxes on Earnings & Withdrawals
The earnings you withdraw from a traditional IRA or 401(K) are taxed as ordinary income. For qualified distributions, you won’t pay taxes on Roth IRAs or Roth 401(K) withdrawals at all.
What Are Different Ways to Build a Retirement Portfolio?
Base decisions about your retirement portfolio on your unique situation. Things to consider include how much money you have, taxes and how long you will need the money to last. Below are a few ways to approach it, along with some advantages and disadvantages. You may want to speak with an advisor about these important decisions.
Many people believe a retirement income plan means just living off the interest that their investments produce. With this approach, you choose low risk investments to fund your income. An example is to use a bond ladder. This is a portfolio of bonds that mature at staggered intervals across a range of maturities.
One advantage is that the principal may stay intact if you choose less risky investments. It also has the potential to produce a higher initial yield than other approaches.
On the flip side, the income you receive can vary. This approach also requires you to know about the underlying securities and the factors that affect the amount of income they pay out. Lastly, the principal can fluctuate by investment type.
Total Return Portfolio
A total return portfolio looks similar to a pre-retirement portfolio with a mix of stocks and bonds. The goal is to keep earning money through stock investments but balance it out with bonds.
This has diversified strategy historically worked for many as they stuck with a disciplined plan. You can adjust withdrawals or spend principal if you need more income.
This approach has no guarantees that you will receive the returns you expect. In addition, you may need to forego inflation raises or reduce withdrawals if your money runs low.
Time Segmentation (Bucket)
With a time segmentation portfolio, you choose investments based on the point in time when you'll need them. It's sometimes called a bucket approach. You put lower risk investments in near-term buckets and higher risk investments in long-term buckets.
You match investments to the job they're intended to do. When you don’t need higher risk investments anytime soon, volatility might bother you less.
There's no guarantee that the higher risk investments will achieve the returns you need over the designated time. In addition, you must decide when to sell higher risk investments to replenish shorter-term time segments. That can get complicated.
What Are Additional Tips For Choosing Investments?
Below are five tips to consider before you invest in any kind of investment. They are especially important for retirement—when you want your money to last.
Top 5 Tips for Choosing Investments
1. Define Your Objective
2. Assess Your Risk
3. Do Your Homework
4. Understand Costs
5. Avoid Market Timing
1. Define your objectives. Is your goal to live comfortably in retirement? If so, how comfortably? You probably have multiple goals. Lay them all out and be as precise as you can. Remember: If you don't know where you're going, you'll never arrive.
2. Assess your risk profile. Different investments carry different risks. Always know the risks before you invest. It's also a good idea to write them down for an easier comparison.
3. Do your homework. Read books and articles about investing. Look up information on our website or visit your local library. Start following commentary on financial news shows and in newspapers. You should also read investment company documents. You will find important objectives, characteristics and risks of the investment.
4. Understand all costs associated with buying and selling an investment. If you work with an advisor, make sure you understand they are paid for transactions, including commissions, mark-ups or mark-downs.
5. Don't try to time the market. Avoid speculating on return rates. Decisions are too often made on where rates have been rather than where they are going. Instead, stick to the investment strategy that will best help you achieve your goals.
Diversification does not assure a profit nor does it protect against loss of principal.
As with all investments, there are risks of fluctuating prices, uncertainty of dividends, rates of return and yields. Current and future holdings are subject to market risk and will fluctuate in value.
Rebalancing allows you to keep your asset allocation in line with your goals. It does not guarantee investment returns and does not eliminate risk.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
Please consult your tax advisor for more detailed information regarding the Roth IRA or for advice regarding your individual situation.
Taxes are deferred until withdrawal if the requirements are met. A 10% penalty may be imposed for withdrawal prior to reaching age 59½.
You could lose money by investing in a mutual fund, even if through your employer's plan or an IRA. An investment in a mutual fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.
IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.
This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.
This fund may be subject to many of the same risks as a direct investment in real estate. These risks include changes in economic conditions, interest rates, property values, property tax increases, overbuilding and increased competition, environmental contamination, zoning and natural disasters. This is due to the fact that the value of the fund's investments may be affected by the value of the real estate owned by the companies in which it invests. To the extent the fund invests in companies that make loans to real estate companies, the fund also may be subject to interest rate risk and credit risk.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.