If you’re age 50 or older and are like most investors,
you’re investing largely in mutual funds through an employer-sponsored
retirement plan. If you have a brokerage account, you’re probably choosing
funds rather than individual stocks.
Investors who have a little more knowledge will often assess
the balance of their holdings and the ratings of the funds they own. They may
subscribe to newsletters or visit financial sites that provide guidance and
recommend stocks and funds.
So much of that guidance, however, is focused on growth —
the potential for price appreciation as investments increase in value. The only
way to turn investment growth into cash is to sell the investment. As investors
get closer to retirement, though, they want to know more about how much income
their portfolios are earning — that is, how much cash their holdings are
actually generating. Growth may be high, but income may be quite low.
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So what is an investor to do? Ride the hills and valleys of
the market and hope for the best from a growth standpoint? Or take steps to
lock in more certainty about income?
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To choose the strategy that’s best for you, it’s important
to understand some income-related financial terms and definitions.
Dividends
Dividends are paid by common and preferred stocks, usually
on a quarterly or semiannual basis. Preferred stocks are a type of fixed-income
instrument, with a guaranteed dividend. Common stocks are the more typical
equity issues; their dividends aren’t guaranteed, although they have greater
potential for growth.
Other income sources
Annuities produce regular, guaranteed payments that are
usually a mix of income and a return of capital. Depending on the annuity,
there may be a guarantee of lifetime income.
Covered calls are an additional source of revenue for people
who own a portfolio of common stocks. Engaging in a call strategy requires an
in-depth conversation with your financial advisor to review your risk tolerance
and the tax implications for realized gains.
What income sources
are right for you?
Well-diversified investors may be using a mixture of all
these strategies to produce the annual income they need from their accounts.
The actual allocation of weight among strategies may depend on the risk
tolerance of the investor, as well as the amount available to invest. All of these
decisions are made in the context of an investor’s need for liquidity — the
ability to convert investments to cash. Investors who are already retired are
normally advised to keep a percentage of assets in cash to have available for
emergency needs. This lets them avoid “fire sale” events should markets turn
down.
[source: http://www.csmonitor.com/Business/Saving-Money/2015/0528/Financial-lingo-to-know-for-retirement-planning]
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