The Best Investments for Income in Retirement


Best investments for income in retirement

You've worked hard for your money. Now it's time to enjoy it.

Finding the best investments for income in retirement will be paramount to your success.


Even with a free investment portfolio review checklist, making your money last won't be easy.

According to the most recent longevity data from the Social Security Administration, a 50-year-old male can expect to live another 30 years, while a 50-year-old female can expect to live for 33 more years.

At age 60, men and women can expect to live another 22 and 25 years, respectively. These statistics highlight the jarring reality that retirees will most likely need to sustain income for decades.

Reaching retirement is a significant milestone and also a time of powerful financial and investment changes. One of those changes is converting your growth portfolio into an income portfolio.


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So, what are the best investments for income in retirement? Here's what we'll cover to help answer that question:

Overview





The best investments for income in retirement should help you create sustainable income for the rest of your life.


Your investments should also help you maintain financial security.

To accomplish these goals, you’ll need to construct an investment portfolio with different investments, each working to complement the other. Unfortunately, there is no single investment that will solve your retirement income problems.


After helping people invest for nearly twenty years, I know this from experience.

The good news is that once you know what you're trying to accomplish, finding the best investments gets a little easier.


While every situation is different, each investment you select should serve as a building block to improve your overall portfolio in the five areas below:


  • Risk

  • Return

  • Cost

  • Taxes

  • Income


For example, ask yourself the following questions:


  • How does the investment I'm considering help me better manage the risk in my portfolio?

  • How does the investment I'm considering help me get the returns I need?

  • How does the investment help reduce my costs?

  • Is the investment tax efficient?

  • How does the investment help my portfolio create the income I need to maintain my lifestyle?


Remember, no investment is perfect for all situations. But when combined together, the best investments for income in retirement should create a total portfolio that helps you create sustainable income for life.


Understanding Diversification

In your working years, growing your portfolio may be a primary concern. But when you retire, your attention often turns toward reducing risk and making your money last.

That’s where portfolio diversification* comes into play.

Diversification is one of the most critical elements of an investment strategy. It is a foundational building block of any investment plan.


Whether you’re a novice investor or in your retirement prime, diversification is a mainstay for any long-term portfolio.

So, when picking investments for retirement, diversification is a telling factor.

Why does diversification hold so much value?

Diversification seeks to manage your portfolio’s exposure to risk and has the potential to increase your portfolio's efficiency.

An efficient portfolio has the potential to do two main things:


  • Increase expected returns

  • Reduce fluctuations in overall portfolio value


While not guaranteed, proper use of diversification may accomplish these two objectives relative to a portfolio that is not adequately diversified.

For example, did you know that all stocks from 1994 to 2020 had a compounded average annual return of 8.2% per year? However, if you exclude the top 25% of performers each year the return drops to -4.7%!


The Best Investments for Income in Retirement - Benefits of Diversification

That’s why diversification matters. If you aren't diversified enough, evidence suggests that there is a high probability that you can end up owning the worst performers.

When it comes to diversifying your investments for income in retirement, remember that your fundamental risk is having too much exposure to a single investment.

Before retirement, you have time to make financial adjustments or work a little longer if something happens.


Your golden years don’t offer the same flexibility.

What factors make a portfolio diversified?

There are many factors that contribute to a well diversified portfolio including:


  • # of holdings

  • Exposure toward stocks, bonds, real estate, or guaranteed income sources

  • Exposure toward value companies and growth companies

  • Exposure toward large and small companies

  • Exposure to guaranteed income sources such as pensions or social security.


In practice, the best investments for income in retirement should contribute toward your overall game plan.


When it comes to creating a retirement income portfolio, the sum of the parts is always more powerful than the individual components by themselves.

In practice, we believe a diversified portfolio should contain thousands of stocks and bonds across many industries and sectors.

Owning just a handful of stocks simply doesn’t cut it.


You can achieve a diversified portfolio by being deliberate in your asset allocation (mix of investments) and selecting a mix of index funds, exchange-traded funds (ETFs), mutual funds, stocks, and bonds.


Remember, your asset allocation should also consider your retirement age, risk tolerance, and retirement goals.

Here is an example of an asset allocation we actually use with clients at Covenant Wealth Advisors.


The Best Investments for Income in Retirement - Example Portfolio Composition

This portfolio may be great for some investors. But it may be terrible for others. It all depends on your personal goals, risk tolerance, tax situation, need for income, and more.


Go global

You should also pay particular attention to geographic diversification. International diversification should always be considered when selecting the best investments for retirement income.


Why?

Investors have a well-documented tendency to heavily invest in companies that are geographically close to them. This habit is called home-country bias.


Unfortunately, "home bias" is as harmful to your retirement income portfolio as concentrating too much in any one industry or sector from a risk perspective.

To consider how undiverse a portfolio composed primarily of investments in the United States is, just consider the size of the non-U.S. equity market.

The chart below shows the world market capitalization of stocks across different countries.

As illustrated in the chart below, the United States represented 57% of the global equity market capitalization in 2020. That’s certainly a lot for one country, but the other 43%, nearly half the opportunity, lies outside the United States!


The Best Investments for Income in Retirement - World Market Capitalization of Stocks

That means the best investments for income in retirement may also be located beyond U.S. borders.

Remember, too, that the power behind diversification lies in how the investments relate to each other when creating a complete portfolio.

When one investment lags, will there be another investment in the portfolio to pick up the slack?

The Best Investments for Income in Retirement - Diversification Smooth Out the Bumps

If all of your investments are going up at the same time, by definition, you aren't diversified! When one investment "Zigs" the other should "Zag".

The point here isn’t to try and guess which investment will outperform another in a given year—you simply can’t. The point is to remember proper diversification and to hold broad exposure to many parts of the global economy.

Now that you have a firm understanding of why diversification is so important in retirement, let’s talk about tax efficiency.

Double Down on Tax Efficiency

When it comes to choosing the best investments for retirement income, don’t forget about taxes!

Once you reach retirement, managing your taxes is one of the best ways to get more out of your savings and increase their longevity.

The investments you select, your withdrawal plan, and even timing strategic decisions like Roth conversions or tax-loss harvesting can all affect how much you will owe in income taxes.

The secret?

Keep taxes top of mind from beginning to end. Proactive tax planning is all about balance, so try to keep a multi-year perspective because sometimes it makes sense to increase your taxes one year to reduce them even more, the next.

Your retirement income plan should consider tax-efficient investments.

After all, it’s how much you earn on an after-tax basis that determines your true return in the first place!

Now that you know the key considerations for a sound retirement income portfolio, let’s dive into the best investments for income in retirement.


1. ETFs and Low-Cost Index Mutual Funds


ETFs make excellent retirement investment vehicles for creating a portfolio designed to provide you with adequate income.

There are several reasons why ETFs are so valuable.

ETFs generally have lower costs.

Investment fees can reduce your total returns over time, so managing your fees should be a top priority both before and during retirement.


ETFs are designed to operate more efficiently than comparable mutual funds, resulting in lower costs on average.


These costs include the administrative expenses of running the fund, management fees, trading costs, and fees associated with marketing the fund.

ETFs are generally tax-efficient.

The ETFs structure also makes them extremely tax-efficient. Compared to mutual funds, it’s much easier to control your capital gains with an ETF.

Why?

Because ETFs do not pass capital gains through to individual investors. Instead, you only incur capital gains on ETFs when you sell them.


This allows you to push more of your capital gains into favorable long-term tax brackets and time the realization of gains to take the best advantage of offsetting capital losses.

ETFs offer better liquidity.

Mutual funds can only be redeemed once per day at their net asset value, which must be tallied after the market closes. ETFs, however, trade just like stocks. This allows you to reallocate your portfolio in real-time rather than once a day.