“But I’m looking to grow my money. Why would I want income investments in my account?”
This is a common question I get from Wela clients as we talk through the process of developing a retirement savings portfolio to meet their particular objectives. It’s a great question that makes sense. And here’s the answer.
When we think about saving for retirement, we often visual our efforts as growing something -- a “nest egg” that expands with every deposit we make in our retirement account.
But a well-crafted retirement strategy is actually more like a machine than an incubator. It has several moving parts that work together to leverage your contributions and move you towards your goal. The twin motors in that machine are growth and income investments, which work together, with each taking the lead at different times in the journey to and through retirement.
Growth stocks are shares in companies that currently prioritize expansion and increased market share. These businesses pour most of their profits back into operations, and thus don’t pay dividends. Netflix and Amazon are good examples. If/as a growth company expands, investors benefit from the steady, sometimes dramatic, rise in value of their shares. Growth stocks are what people talk about at the office coffee machine. “Yeah, I bought Acme Corp at $10 a share five years ago and just sold it for $71.”
Income stocks are boring by comparison. They tend to be established companies in mature industries – think Proctor & Gamble, Apple, Disney – that are unlikely to show dramatic growth in share price. Instead they just ton the revenue and pay their shareholders a regular dividend.
Bonds, which are essentially a loan to a business or government, are another source of income, as owners of the bond receive regular interest payments. Investors can also receive income from alternative investments, including real estate investment trusts, preferred stocks and shares in pipeline and energy storage companies. All of these assets are traded on open markets like stocks and bonds.
So, let’s assemble Wela’s version of the retirement investment machine. It consists of three buckets based on the above – stocks, bonds and alternative investments – designed to grow your money while providing diversity to protect you from market volatility.
Stocks – During most of your working career, your portfolio should contain mostly shares in growth companies. Ideally, these stocks will significantly appreciate in value over the years and decades, providing a nice profit when you liquidate them in retirement.
But you should also hold some income stocks to provide diversification and stability. The dividends these shares pay can be reinvested in your portfolio, turbo-charging your growth.
When you retire, we recommend shifting your focus to income stocks. You can continue to reinvest their dividend income, or use it to help fund your lifestyle. Income stocks also tend to be less volatile than growth shares and thus offer the stability you want in retirement.
Bonds – Contributions to this bucket are invested in a diversified range of bonds – Treasury municipal and corporate – that will provide a steady stream of interest income while protecting your principal.
Your portfolio should hold a greater percentage of bonds (as opposed to stocks), as you get closer to retirement. We recommend, “owning your age” in bonds. When you are in your 40’s, bonds should make up 40% of your portfolio. When you are 50, that percentage should be 50%.
Alternative investments – This smallest bucket of non-stock or bond assets provides more income and some insulation from the gyrations of the stock market.
So, why should you hold income investment when you’re seeking growth? Because income investments – stocks, bonds and alternative investments – can both enhance and protect that growth. The dividends, interest and other payments generated by income assets can be reinvested, even as those assets themselves insulate you from volatility by providing diversity and stability.
Your investment machine isn’t hitting on all cylinders unless you have income assets in the fuel mix.
Disclosure: The information is provided to you as a resource for educational purposes only. Nothing herein should be considered investment, legal, or tax advice. Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results when considering any investment vehicle. This information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. It is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax, or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.