Investors seeking income in a low-interest world can be broken down into two different types, according to Craig Adamson, a financial advisor with True Wealth Stewardship.
That would be people who are undersaved and people who are oversaved.
As we've noted in previous columns, higher income payouts come with various rules and risks that don't come from CDs and savings accounts. And we should also note that Adamson's comments are meant to be general in nature and not specific investment advice. In other words, talk to a financial/investment advisor before acting on this commentary.
That said, in general, if someone is "undersaved" for retirement and they are unable or unwilling to return to work, they have to do some soul searching. "They would need to ask themselves the following," said Adamson. "Would I rather take more risk and have the chance that things won't work out? Or would I rather lose the flexibility of accessing all of my money, but have guaranteed amount and source for my monthly income?"
What are some options? The first, according to Adamson, is using annuities with lifetime income riders.
"Because you are committing a good amount of capital up front to get big enough payouts to meet needs, you can look at an annuity to meet either lifestyle needs, or preferably to match the monthly payment with specific expenses such as a mortgage payment, prescription drug coverage, Medicare premiums and supplements, utilities, and the like," said Adamson.
These would be "things that you basically know the monthly cost of, so you know how much income you need before you buy an annuity. That would be the more conservative way to go for someone who is 'undersaved.'"
Another option, he said, might be to pair five- or 10-year immediate annuities with a stock portfolio that generates part of its total return from dividends. "While you do have the risk of the stock market going down, you know with the immediate annuity you are getting five or 10 years of monthly income while you can hopefully allow your stock portfolio time to grow and compound," said Adamson.
This, he said, is the more traditional bucket strategy of having money now, in five to 10 years, and then beyond 10 years. "Granted, you'd spend down the immediate annuity money, but it would likely be the more conservative route to go if you wanted to not miss out on possible stock market growth in the meantime."
It also allows you to have a portion of your portfolio 100% liquid, said Adamson, who is quick to note that he typically recommends having six to 12 months of expenses in cash to cover an emergency regardless.
"This keeps people from sabotaging the strategy if we have a downturn in the first year or two of implementing the strategy," said Adamson.
The other option for the undersaved, said Adamson, is pairing a Home Equity Conversion Mortgages (HECM) for Seniors (a reverse mortgage) with a more stock-heavy investment strategy.
"Of course, a trained and licensed professional in that area would help determine if someone qualifies or not for a HECM," Adamson said. "For someone over age 62 with a mortgage this could help relieve the monthly cash-flow pressure and not as much money may need to be committed to the annuity strategy," he said. "Or if their mortgage was paid off, periodic withdrawals when stock markets are down would minimize the shock of a drop and help investors stay fully invested through a down time in the market."
As for those who are oversaved, Adamson said they could incorporate any or all the strategies mentioned previously. "Because we are creating and stress-testing a financial plan before we implement and investment strategy, most of our clients in this category are willing to take on some additional risk," he said. "This allows us to utilize high-dividend paying stocks like REITs and business development companies to generate income."
To be fair, Adamson said we are already seeing early signs of principal erosion due to monetary policy talk. "But if the goal is to generate current income, a client would need to understand up front that we are buying riskier assets for the dividend and they might see statement balance go down while income goes up," he noted.
There are even riskier assets that investors can use to generate high current income. Those include high-yield bond funds, as well as preferred stock ETFs and mutual funds. In addition, investors might consider closed-end funds (CEFs) -- typically purchased in unit investment trusts (UIT) -- for high current income.
"A unit investment trust is an investment company that buys a fixed portfolio of stocks or bonds," according to the Investment Company Institute. "A UIT holds its securities until the trust's termination date. When a trust is dissolved, proceeds from the securities are paid to shareholders. UITs often have a fixed number of shares or 'units' that are sold to investors in an initial public offering. If some shareholders redeem units, the UIT or its sponsor may purchase them and reoffer them to the public."
The big thing for advisors and clients to understand, said Adamson, is how much leverage the closed-end funds employ. "Higher rates make borrowing more expensive so that can minimize yield or cause the net asset value (NAV) of shares to fall as rates rise," he said.
"But there are many CEF strategies to choose from that use minimal leverage." Finally, Adamson said, it's important for clients who are looking to increase current income to be talking to their advisor about what their needs are. "Are they being open and honest with themselves?" he asked. "If not, they could be setting themselves and their advisor up for failure."
They also need to be candid about what they can tolerate for risk. "Everything paying decent interest is risky," he said. "This isn't the 1990s when you could get a money market mutual fund paying 4.5%."
Adamson noted, too, that stocks are at all-time highs. "But that isn't a reason not to take on some risk to finance your retirement income needs," he said.
"The stock and bond markets have always been risky. People need to understand what the rules of the game are and what that might look like on their statements and on their balance sheet. Sometimes those investment accounts don't look as nice, even though their checking account looks much fatter."
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