Managing Investment Portfolios

Income Investments

At least some portion of your portfolio is likely to consist of income-producing investments, such as bonds and dividend-yielding stocks, and perhaps bank products, as well, such as CDs. Income-producing investments are especially important in retirement, because once you stop working you typically need this money to live on.

For instance, income from the interest on a bond or the dividends from a stock could help cover your day-to-day expenses. Since those payments are made regularly—such as quarterly or semiannually—you can usually plan for and count on them well in advance. If you don’t need the money for day-to-day expenses, you can also use income from your investments as a regular source of new investment money, or you might choose to spend a certain amount for specific expenses and reinvest the remainder.

Bonds are traditionally considered reliable income-producing investments—in fact, they’re also called fixed-income investments. When you buy and hold a bond, you receive a regular interest payment every six months or year, plus you’re promised the principal back when the bond matures.

Bonds aren’t foolproof. Their market value can fall if interest rates rise or other factors undermine investor confidence in them. But because bonds issued by the US government, most state and local governments, and high-rated corporations have a low probability of default—that is, failure to pay what’s due—these investments might appeal if you need steady income and don’t want to risk your principal.

Laddering is an effective bond investment strategy that works with CDs as well. When you create a bond ladder, you divide the entire principal you’re allocating to bonds into three or four parts and invest each part separately. For example, instead of investing $20,000 in a single issue, you’d invest $5,000 in four different issues of intermediate-term bonds. The idea is to have one bond mature every year or two—say 2007, 2009, 2011, and 2013. You extend the ladder by reinvesting the maturing bond in a bond maturing in 2015.

The dual advantage of laddering is that if you need to use some of your principal for living expenses or extraordinary costs, you have a certain amount maturing on a regular schedule. In addition, if interest rates happen to be down when one of your bonds matures and needs to be reinvested, you aren’t sacrificing yield on the entire amount. By the time the next bond matures, rates may be up again.

Dividends are investment income you receive on preferred or common stock you own. Corporations may choose to pay out part of their earnings as dividends to you and other shareholders as a return on your investment. For instance, if a company declares an annual dividend of $2 per share and you own 200 shares, you’ll get $400 during the year, typically in quarterly payments. A company’s board of directors decides how large a dividend the company will pay—or whether it will pay one at all.

If you’re seeking income from stock, the advantage of preferred stock is that the dividends are often guaranteed and are paid before dividends on common stock. However, they may not increase if the company’s profits increase and it declares a larger common stock dividend.