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By Matt Frankel, Investment Planning Investing For Income: Which is the best way for you? 1

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By Matt Frankel, Investment Planning

Investing For Income: Which is the best way for you?

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• When it comes to investing for income, there are several choices, including:– Bonds – Dividend stocks– Annuities– CDs

Source: 401kcalculator.org via Flickr

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Let’s take a closer look at each type

of income investment…

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• Bonds pay a fixed dollar amount of interest per year.

• When the bond matures, your original investment is returned.

• For example, if you buy a 30-year corporate bond for $1,000 with a “coupon rate” of 6%, you’ll receive $60 per year for 30 years, and then your original $1,000 will be returned.

Note: Coupon rate refers to the interest rate a bond pays as a percentage of its face value

1. Bonds

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• Even though a bond pays a fixed interest rate, its value can change in response to prevailing interest rates or changes in the credit quality of the issuer.

• This affects bonds with longer maturities more than short-term bonds.

• Bonds also have inflation risk– Since your income doesn’t change, inflation

can erode your purchasing power over time.

Bond risks

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• Consider a Treasury bond with a 4% yield (face value $1,000)

• If market interest rates rise to 5%, that’s what investors will expect to receive.

• So, your bond’s face value could drop to roughly $800.

• In reality, the bond will still return $1,000 at maturity, so it’s value wouldn’t drop quite that much.

• However, interest rate risk is something to keep in mind when investing in bonds.

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Here are some of the pros and cons of investing in bonds

Pros Cons

Steady, predictable income Interest rate, credit risk, and inflation risk

Prices tend to be less volatile than stocks

Long-term returns tend to be lower than other asset classes

Can be safe (investment-grade)

To get a higher yield, you need to take on more risk (“junk” bonds)

Potential tax benefits (municipal bonds, for example)

Some bonds have low liquidity

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• Dividend stocks have the potential for excellent long-term returns, since they could go up in value over time

• And, the dividend payments could increase over time, helping your income keep pace with inflation

• However, there can be more risk of a loss than most other income investments

2. Dividend stocks

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• The best dividend stocks tend to have certain characteristics– A solid history of growing

revenue– Annual dividend increases– Large companies with

diverse revenue streams– Stocks that pay out a

relatively low percentage of their earnings Source: 401kcalculator.org via Flickr

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Stock (Symbol)

Current Yield

Years of consecutive increases

Procter & Gamble (PG)

3.25% 58

3M (MMM) 2.63% 56

Coca Cola (KO)

3.20% 52

Johnson & Johnson (JNJ)

2.99% 52

Target (TGT) 2.53% 47

Wal-Mart (WMT)

2.69% 40

McDonald’s (MCD)

3.49% 38

• A good example are the dividend aristocrats

• These are stocks that have increased their dividends for at least 25 consecutive years

• A sampling of the dividend aristocrats is listed here

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• Dividend stocks should be a staple of every income portfolio– However, make sure you invest in high-quality

dividend stocks like the ones mentioned here– As you get older, it’s wise to reduce your

exposure to stocks • One popular guideline to determine the percentage

of your portfolio that should be invested in stocks is to subtract your age from 110

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• An annuity is essentially a lump sum payment to a company in exchange for a guaranteed income stream for life

• While an annuity can provide worry-free income, there are some things to keep in mind…

3. Annuities

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• Many annuities have high fees, especially the more complex types

• There is a saying “annuities are not bought, they are sold”

• Make sure you compare the fees from several companies before choosing an annuity

Source: Flickr user quazie

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• Immediate annuity – The simplest kind, where you exchange a sum of money for an income stream.

• Deferred-income annuity – Exchange of money for an income stream that begins in the future.

• Fixed annuity – Income payments are fixed for a certain amount of time.

• Variable annuity – Income payments vary over time, depending on performance of underlying investments.

Major types of annuities

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Annuity pros and cons…Pros Cons

Steady income for life Inflation risk

Principle protection is available

Low returns when annuities are purchased in low-rate environments

Potential tax advantages Some have high fees

Potential negative tax implications for your heirs

Click here if you’d like to learn more about annuities

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• CDs are the among the safest income investments you can possibly make

• CDs are guaranteed by the FDIC up to $____

• While CDs pay more interest than savings accounts, you are required to keep your money tied up for a certain length of time

4. Certificates of Deposit (CDs)

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• The biggest downside to investing in CDs is the low return potential

• In fact, the income you get from CDs is unlikely to even keep pace with inflation

National average CD interest rates (as of August 18, 2015)

Time to maturity Interest rate

3 months 0.15%

6 months 0.23%

1 year 0.37%

2 years 0.57%

3 years 0.78%

5 years 1.20%

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• Of course, there are other ways to create income, such as– Purchasing investment properties to rent out– Buying a business– Peer-to-peer lending– Preferred stocks

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• These can all be valid ways to generate income in retirement

• However, the majority of retirees can use the four methods mentioned here to meet their income needs