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Best Retirement Investments for a Steady Stream of Income

Dana Anspach

December 12, 2019

At some point you will transition from your prime earning and saving years to that time where you will need to “live off your acorns.” These will be the years when you will be drawing from your accumulated nest egg. Before you enter this phase, you’ll need to find the best retirement investments; ones that generate regular cash flow. For most people, the best retirement income plan uses a strategically selected combination of the following investment types.

1) Immediate Annuities

Immediate annuities provide guaranteed income immediately (hence the name). They are a form of insurance rather than an investment (but still included here because they provide steady cash flow). A ten-year term-certain annuity, for example, buys a stream of income for ten years. Because immediate annuities start paying out right away, they appeal to people already retired. They are not for everyone – they tie up assets, and you may “lose” money if you die before fully “cashing out.” Immediate annuities may be advantageous if you have trouble staying within your spending limits, cannot stick to an investment plan, or have no monthly sources of income besides Social Security.

2) Bonds

Bonds, individual or bundled-in funds, are loans you give to governments, municipalities, or corporations that then pay you regular interest. When the bond matures, its face value is returned to you. A time-segmented or asset-liability matching investment strategy will use bonds in a bond ladder, which is a collection of bonds that have different maturity dates set to match your future cash flow needs. Bonds are a lower-risk option than stocks, but during periods of rising interest rates, bonds go down in value. If you are holding the individual bonds to maturity, this decrease has little impact on you, but if you are in a bond fund, the share price will drop, and you may lose money if you sell it during that time. We prefer using individual bonds in our retirement income portfolios. Buy bonds not to grow money but for the regular interest income they produce, and for the structured principal amounts you receive when they mature.

3) Retirement Income Funds

Retirement income funds are great for folks who aren’t interested in keeping regular tabs on their portfolio. They are a type of mutual fund which automatically invests your money in a diversified portfolio of stocks and bonds. The fund’s goal is to produce monthly income. Most people have experience with mutual funds, so they feel comfortable with retirement income funds. And, like mutual funds, retirement income funds are set up so you can access your money at any time. You may see these funds listed with a name like “Target Date 2040” which means the fund is structuring the investments to align with someone who wants to retire in about 2040. Other funds will have the words “retirement income” in their name such as Vanguard’s Target Retirement Income Fund, geared towards those already in retirement.

4) Rental Real Estate

Renting out property for income requires a hands-on approach and, in many cases, more work than you may desire during your golden years. Research and forethought are key. Before you decide to become a landlord in retirement, consider the rental property expenses you may incur over the time frame you plan to own the property, like maintenance, damage from negligent renters, natural disasters, etc. You also need to factor in vacancy rates—no property remains rented 100 percent of the time. For those with a real estate background, or if you want to put the time in, real estate can be a great source of regular income, but go in with your eyes wide open.

5) Real Estate Investment Trusts (REITs)

A REIT (Real Estate Investment Trust) is a mutual fund that aggregates real estate holdings (apartment buildings, commercial structures, vacation properties, etc.). For a fee, professionals manage the properties, collect rent, and pay expenses, and you receive the remaining income. As part of a diversified portfolio, REITs can be a good retirement investment choice.

6) Variable Annuity With a Lifetime Income Rider

I devote twelve pages in my book Control Your Retirement Destiny to variable annuities. That’s because they’re complicated. In a variable annuity, your money goes into a portfolio of investments you choose. For a fee, you can add an optional benefit called a rider. The rider insures the amount of future income you can withdraw from your portfolio. Variable annuities come in many flavors, and many people who offer them don’t truly understand them. Be cautious – sometimes, I see variable annuities with total fees running about three to four percent a year. Your investments will have to earn back the fees and more for you to benefit.

7) Closed-End Funds

Not for newbie investors, closed-end funds encompass a wide range of investment approaches that may be unfamiliar to the layman (they overlay stocks and bonds with strategies like dividend captures and covered calls). Income comes from interest, dividends, premiums from selling options like covered calls, or return of principal. Some closed-end funds use leverage (they borrow against the portfolio) —an additional risk that is employed to buy more income-producing securities so the fund can pay an overall higher yield. Closed-end funds can be a great retirement investment option, as part of a mix, for savvy investors.

8) Dividend Income Funds

A dividend income fund, like other funds, is a collection of stocks overseen by a fund manager. The dividends you receive come from the dividends paid out by the underlying stocks in the fund. Dividends can rise one year and fall the next. Some publicly-traded companies generate qualified dividends, which are taxed at a lower rate than other income. As such, it may be most tax-efficient to hold qualified dividends within non-retirement accounts (meaning not inside of an IRA, Roth IRA, 401(k), etc.). I caution clients to be wary of funds that advertise high yields – yields that are higher than average typically come with additional risks.

9) Total Return Portfolio

When done right, a total return portfolio is one of the best retirement investments out there. It is not a stand-alone investment; it is a strategy that uses a balanced, diverse blend of stock and bond index funds that provide retirement income in the form of interest, dividends, and capital gains. The portfolio is designed to achieve a respectable long-term rate of return, and along the way, you follow a prescribed set of withdrawal rate rules that will typically allow you to take out 4-7 percent a year and, in some years, increase your withdrawal for inflation. What does “total return” mean? Well, unlike a Certificate of Deposit, which has a specific interest rate, with a total return portfolio, you don’t know what the actual return will be each year. Some years, your investments could be up 14%, and other years, down -14%. But over a ten-year span of time an appropriately structured mix of investments, such as 60% stock index funds and 40% bonds, has a high probability of earning a 6-7% average rate of return. So you are targeting that “total” average return rather than knowing the exact outcome each year.

Parting Thoughts

This article is an introduction to income-generating retirement investments. To learn more, check out the Control Your Retirement Destiny podcast (particularly Episode 5 on Investing) on either iTunes or Podbean.

Keep in mind many of the choices discussed above are investment products, not financial planning tools. Many financial advisors are salespeople who place too much emphasis on investment selection and investment products and too little on planning. Make sure you have a well-designed retirement income plan in place before you buy any financial product.