Your portfolio should fit your needs
All investors want portfolios that generate the right amount of income for their needs. This is clearly the case for investors in retirement, who depend entirely on their investments and savings for income. However, even for those investors who have many decades until retirement, having their portfolios generate some income (instead of simply focusing on the appreciation of stock) can still help to diversify their investments and create stability in their returns.
Short-term income may limit long-term gains
There is often a trade-off between short-term income and long-term portfolio growth. Investing in safer bonds that generate income tends to reduce longer-term gains that you could have earned by investing in stocks. Deciding between income and growth depends on your personal financial objectives – it’s hard to have your cake and eat it too. Striking the right balance between receiving income today and growing your assets for the future requires some careful thought and planning.
The higher the potential yield, the higher the risk
Luckily for those who definitely need income today, there are many types of investments that can generate “yield” – a term synonymous with investment income. Yield is normally received through interest payments or dividends generated from investments. The level of yield can vary significantly depending on the riskiness of an investment, especially as it relates to bonds and their associated credit ratings, and can also change over time. That’s why, like all portfolio decisions, careful consideration is needed to determine if the yield on an investment is worth the risk.
Bonds may help provide consistent income
The simplest and most stable strategy to generate portfolio income is through investments in conservative, low volatility bonds, especially via an exchange-traded fund (ETF) or mutual fund. Doing so provides diversification across hundreds or thousands of bonds, while the “safer” nature of these bonds provides portfolio stability. The shorter the duration or time to maturity of the bonds, usually means lower risk for the portfolio. This approach can, when used appropriately, serve as the foundation for many types of portfolios and investors.
Investment income is still taxable
One additional issue to consider is the tax consequence of receiving income. Any interest or dividend payment you receive is taxable that year at the individual’s tax rate for ordinary income. Thus, receiving income from your investments forces you to pay taxes today, rather than in the future when you might sell. This is yet another reason it’s important to carefully consider how much income you need and whether you truly need it today.