As younger people are wising up about their money — determined not to make the same kinds of mistakes their parents and even grandparents made — they may get to face an exciting prospect: early retirement. In fact, I retired at age 28 with more than $2 million!
Even though they've broken free from the trap of working 9 to 5, retirees young and old still need money. And especially if you're younger than the traditional retirement age and therefore can't receive Social Security checks (not that anyone should have to depend on them), you'll probably need to find a source of something called fixed income.
Fixed income plays a central role in every retiree’s portfolio, no matter their age. Because fixed-income streams make regular cash payouts, they're the perfect tools to cover a retiree’s recurring annual living expenses.
So where can a retiree find the best fixed-income options for his or her portfolio? Here are six ways to generate the fixed income you need.
Fixed-Income Earner #1: Bonds
Bonds are among the best-known fixed-income options in the market. With bonds, government entities and corporations borrow money and offer a set coupon to be paid to you in interest each year.
Municipal vs. Corporate Bonds
As a bondholder, one of your chief considerations is whether you believe the borrowing entity is healthy enough to continue servicing their loans. As such, your first consideration will be what type of borrower you’d want to do business with.
Municipal bonds — bonds issued by a local, state, or federal government entity — are usually considered the safest, as they are typically backstopped by the balance sheet of an entire city, state or the federal government. Because they're generally so safe, the rates they offer are also generally the lowest.
Corporate bonds — bonds issued by an individual business — can vary highly in risk level and coupon rate.
Your second key consideration as a bondholder is what your net return will be in purchasing the bonds. Some bonds — most notably, municipal bonds — are federal and state tax exempt. The combination of risk vs. reward may look more attractive for municipal bonds when you factor in the net return against their corporate counterparts.
Bond Funds vs. Individual Bonds
If you are interested in investing in bonds, you can invest in them in one of two ways. First, you can use a brokerage firm to purchase individual bonds. You will be free to hold the bond through to maturity, receiving your distributions and — ultimately — the repayment of the principal, or selling the bond along the way in the secondary market. Alternatively, you could invest in a bond fund, in which a manager pools your cash and others’ to purchase a basket of bonds.
Fixed-Income Earner #2: Dividend-Producing Stocks
Highly profitable, mature companies may find that distributing a large chunk of their profits in the form of dividends is the best way to serve their shareholders. This has created a healthy stable of companies that offer rich dividend-producing stocks. Many of these companies offer different classes of shares, and the highest dividend options you will find are generally their preferred stock offerings.
When evaluating dividend-producing stocks, be aware that there's always the risk that the company may suspend dividend payments. Evaluating the strength of the company’s business and balance sheet, as well as its history of successfully paying regular dividends, is very important. Utility companies and banks are two categories that offer rich dividends.
To sweeten the pot, some stocks on offer qualify for Qualified Dividends tax treatment, meaning you pay an advantaged, lower rate on dividends you receive. In addition, because you have purchased equity, there is often appreciation upside to your holding should the company continue to grow healthily.
The Dividend Aristocrats are 50 companies that have increased their dividends (not just left them the same) for the past 25 years. This list is a good place to start when looking out for dividend income.
Fixed-Income Earner #3: Annuities
You might also consider investing a portion of your portfolio into annuities. An annuity is a contract with an insurance firm whereby you pay in an amount (either in lump sum or regular payments) and are guaranteed a regular stream of income.
Note that the health of the insurer is paramount. The insurer takes your money and invests it in a portfolio of investments, hoping to pay you the set amount you agreed upon and keeping any additional profits for itself that come from its ability to make your money generate more than it guaranteed to you in payment, and from the spread of average mortality age among all annuity customers.
Annuities typically have some of the lowest yields among fixed-income opportunities. A decades-long guarantee doesn’t come cheap.
Fixed-Income Earner #4: Certificates of Deposit
A certificate of deposit (CD) is an instrument sold by commercial banks. The certificate specifics a fixed interest rate and maturity date. It then pays you the agreed-upon interest for each time period, with a repayment of the principal at the maturity date.
Your access to funds in a CD is restricted. Often you can withdraw your money, but you'll be charged a hefty early withdrawal penalty.
At Investor Junkie, we've compiled some of the best resources for finding stellar CD rates.
Fixed-Income Earner #5: TIPS
Treasury inflation-protected securities (TIPS) are securities offered by the government. TIPS will pay you an agreed-upon rate, plus an adjustment for inflation as measured by the Consumer Price Index. TIPs are considered one of the safest fixed-income options because they are back by the federal government. TIPS pay interest twice a year and are issued in five-, 10-, and 30-year periods.
Fixed-Income Earner #6: Rental Property
Rental income is one of the most underrated fixed-income options in the retirement world. While they require the most work, they also offer you some of the highest returns, often 8%-plus a year while also providing you with additional upside potential through appreciation of the property. Rental properties are particularly intriguing in low interest rate environments, as you can borrow a significant percentage of the value of the home at low rates, juicing your returns.
If you don’t want the hassle of managing a property directly, there are other options along the spectrum. Evaluate a potential rental investment while factoring in the cost of hiring a property management company. If that’s still too much hassle for you, you can consider a equity real estate investment trust (REIT). Equity REITS own and manage property.
Whether you're retiring at 28 or 68, these six fixed-income options can offer you steady, regular streams of money. Which one appeals the most to you?