Cash is king, especially in an inflationary environment where the costs of consumer goods are on the rise.
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Every one strives to increase their income, but those gearing up for retirement should be paying particular attention to revenue-generating investments.
“During inflationary periods, investing in areas that can grow your income, such as dividend-growing stocks, will over time help offset the impact of inflation,” says Linda Bakhshian, a portfolio manager at Federated Investors. “Depending on your level of risk tolerance, you can find yield in number of different places.”
Your age is a major factor when choosing investments to generate income. The younger you are the less you have to worry, while those headed toward the labor market’s exit sign will want to be able to access cash.
Money managers don’t propose investors put all their money in income-generating products, but they do insist on well-diversified investments.
“Once you have that foundation and diversification and you encounter a greater need for income, you can start overweighting or emphasizing these different asset classes that have higher amounts of income,” says Mike Loewengart, director of investment strategy at E*Trade.
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Dividend-paying stocks are one way to generate income, but the return will differ. Typically companies that are paying a high yield are in more volatile sectors than those that pay a low dividend.
According to Nicholas Yrizarry of Nicholas Yrizarry Wealth Management Group, the uutility sector is traditionally where investors go for dividend-paying stocks. He says investors can also invest in a real estate investment trust (REIT), which can pay higher dividends than a utility company. A REIT is a type of security that trades on stock market exchanges that invests in real estate.
“Health care and real estate, for example, typically pay a higher dividend because of the demand for health care as baby boomers age,” he says.
Experts say investors can also overweight their equity positions to stocks that have above-average dividend yields as a way to generate income. “Historically, 40% of market returns have come from dividends,” says Bakhshian. “Diversifying across asset classes, sectors and securities may minimize volatility and protect on the downside.”
Bonds, a fixed-income product, will also pay a yield. While some of the safer bonds aren’t generating a high yield or return, Loewengart says many investors are focusing on corporate bonds.
“It’s a way to earn incrementally higher income beyond what the treasuries are paying,” he says, noting the 10-year treasury is yielding only 2.5%. Bonds tend to be less uncertain than other investments, but that doesn’t mean they are risk free, he adds.
For more sophisticated investors, they can generate income using options in a strategy called writing a covered call. With this strategy, you sell a call on a stock you already own. The sale then adds cash to your account. But the transaction isn’t risk free. If the call is exercised, you have to sell the stock regardless of the current price.
“If you have a neutral outlook for equities this would be an appropriate strategy to generate income of your existing portfolio,” says Loewengart. He notes that any investors trying to generate income out of their investments have to be aware of the tax consequences. For instance, you have to pay taxes on dividend income, but with a municipal bond the return may not be high to trigger having to pay taxes. In some states you won’t have to pay any taxes on the return from a muni.
While some investors may need access to their cash, Yrizarry says that shouldn’t be the main goal. He advocates having six to eight months of cash reserves in a money market to circumvent drawing cash out of the investment portfolio in case unexpected costs come up.
“The very process of successful investing is hampered by investors wanting or needing their monies during emergencies or down markets,” he says. By having cash in a money market account, “the integrity of the investment process can be maintained.”