Doing the income two-step

With interest rates at historical lows, you may need to dance a different step to squeeze more income out of your investments. When market conditions are difficult, it can help to divide your income portfolio into guaranteed and variable portions. Use guaranteed income to cover basic living expenses and variable income to pay your other expenses. Looking at your resources this way, you can adjust the risks you are willing to take against the certainty of the income.

For our first step, cover your basic living expenses with low risk sources of income. Put together a complete list of your basic living expenses. These include groceries, mortgage or rent, utilities, insurance, clothing, medical, transportation and other necessities. A good blank expense form is available at www.todaysseniors.com in Money – Budgets section. See if you can cover your basic living expenses with income from Social Security, pensions or immediate annuities. If these are adequate, you can sleep well knowing your basic bills are covered. If you don’t have enough guaranteed income, consider an immediate annuity, or another low-risk investment to assure the basics are covered.

Step two; find investments that will pay for the things you enjoy but do not require. Many people will be comfortable risking this income, which will not be as steady, for the reward of increasing the average return. If this income drops, you could choose to delay spending the money until things get better. Consider an investment that is providing cash so you can take a vacation every year. Would you will be willing to risk taking a vacation every year for the opportunity to go to Europe every five years, with shorter, less costly trips in between? If so, a riskier investment may be acceptable for this goal. Before choosing where to invest, determine the amount you are willing to risk.

Once you have decided what you can risk, when you want the return and how much, you can choose where to put your money.

When returns from high quality bonds, CDs, money markets and bank accounts are low, consider diversifying into high dividend stocks, lower quality bonds, Real Estate Investment Trusts, companies making money collecting a toll such as pipelines, or other alternative investments. All of these have the potential to provide higher rates of income. Companies with good cash flows paying a high, but reasonable, dividend are usually strong and more likely to survive difficult times. Low quality bonds pay a higher interest rate but have a higher average default rate.

REITs and Master Limited Partnerships can provide high yields in part because of their tax structure. Each has specific risks and performs differently in varying economic conditions.

When researching possibilities consider various risks such as, not receiving payments on time or your original principal back, lack of liquidity (ability to sell quickly without losing value), transaction and operating costs, past track record, management performance and experience. You can easily, and inexpensively, research the possibilities through financial publications and Internet sites such as Morningstar, Financial Times, The Wall Street Journal, American Association of Individual Investors and others. Diversify your sources to avoid biased information. If you are not comfortable doing this work yourself, get qualified professional advice to help you through the process.

The income two-step is not difficult to learn and can help you optimize your investments when market returns are low. The key is to match the risk you are willing to take, with the investment goal. The benefits are, sleeping better knowing your basic expenses are covered and still being able to achieve some of your discretionary goals. Get dancing!

Tom Roberts, principal of A New Approach Financial Planning in Lakewood Ranch, can be reached at (941) 927-9590 or Tom@ANewApproachFP.com.