When you retire, where can you find investment income?
As an investor, your main goals will change at different times in your life. During your working years, you need to grow as many resources as possible for retirement. Once you retire, however, you will likely need to focus more on getting income from your investments. But what are your options?
There’s no shortage of income-producing investments, of course. You might immediately think of bonds, which can provide regular interest payments and probable preservation of principal, provided the bonds are considered “investment grade.” Still, if interest rates are low when you retire — as they have been for several years now — bonds might not provide you with as much income as you need. And just as importantly, the income you receive from most bonds won’t rise over time, leaving you susceptible to inflation and the loss of purchasing power.
Consequently, you may also need to explore other types of income-generating vehicles, including dividend-paying stocks and real estate investment trusts (REITs).
Some stocks have not only paid but also increased their dividends for many consecutive years. These stocks have historically provided the potential for rising income to help combat inflation and are typically well-run companies that strive to reward their investors. Nonetheless, you need to recognize that even these stocks are not obligated to pay you dividends, and they are free to lower or discontinue them at any time without notice.
Now, let’s turn to a second type of potential income-producing asset: Real estate investment trusts (REITs).
Different types of REITs are available. For example, equity REITs invest in and own commercial properties, such as hotels and shopping centers, while mortgage REITs, as the name suggests, own and invest in property mortgages. Is one form of REIT better than another? There’s no simple answer. On the one hand, mortgage REITs are considered riskier than equity REITs. However, mortgage REITs often pay quite large dividends, although the payout can be inconsistent. (Like all REITs, mortgage REITs must pay 90 percent of their taxable income to investors in the form of dividends. Due to this requirement, REITs generally need to raise capital to finance their growth plans, and this necessity can affect their share prices.)
Other factors, such as changing interest rates, will affect the value of mortgage and equity REITs differently. Specifically, rising interest rates will likely cause the market value of the property mortgages inside mortgage REITs to fall, whereas equity REITs, which own actual buildings, might actually benefit if the Federal Reserve raises interest rates, as such a move would indicate a strong economy, more jobs and greater demand for office space. In the short term, though, even equity REITs can react negatively to an interest-rate increase. But over the long term, this movement can be offset by the benefits of earnings and dividend growth driven by a growing economy.
Clearly, there’s much to think about when considering potential income-producing options such as bonds, dividend-paying stocks and REITs. Ultimately, you will need to weigh the merits and risks of these investments — including interest rate risk, credit risk and market risk — and determine which of them, or which combination of them, are most appropriate for your needs.
This article was written by Edward Jones for use by your local Edward Jones Financial Adviser. Douglas J. Drost CFP Financial Adviser for Edward Jones, 2262 Reno Highway.