The road to financial freedom in retirement can seem more like a tangled maze. Along the way, you confront crucial questions, like how much do you need to save, how to maximize your savings through investments, and what investment strategy (or strategies) will work best for you.
Unfortunately, there is no one-size-fits-all approach to this challenge; everyone’s situation is different. You need your own, individual roadmap, in the form of a solid investment plan.
While there are dozens of investment strategies (all of which have their merits and advocates), I want to introduce and explain my core philosophy – income investing.
Introducing Income Investing
I’m a huge believer in incoming investing. I have used this strategy to help countless clients reach successful retirements. It is also a focus of my book, You Can Retire Sooner Than You Think. Let’s talk about how income investing could safely navigate you to your retirement (and overall financial) finish line.
The premise behind income investing is simple – you want to generate cash flow from your investment holdings. You do this by acquiring stocks, bonds and other assets that generate revenue from dividends, interest and similar payments. The money you receive is then reinvested to accelerate the growth of your portfolio. Rinse and repeat until you retire, when the income from your investments gets redirected to provide you with a “paycheck” to fund your post-career financial needs.
How Income Investing is Different
Income investing differs from the old stalwart of pure growth investing. Under the pure growth strategy, you buy shares of companies that are focusing all their resources (including profits) on expansion and domination. Think Alphabet (parent company of Google) and Amazon. With pure growth, you reap your profits when you sell these stocks after they have (hopefully) appreciated for 10, 20, or 30 years.
With income investing, we approach wealth creation from a different angle. To some extent, it provides a broader range of growth opportunities, by allowing for more diversification; generating steady, predictable income over the years; and allowing you to share in the growth sector.
How to Become an Income Investor
There are many ways to implement an income investing strategy. Some are dauntingly complex. But I’ve developed a system that I believe is easy to understand and execute.
I call it the “Bucket System,” as all the money you invest will fall into one of four asset groups, or “buckets,” that work together to move you towards your goals.
Cash Bucket – This is your emergency fund, also known as your rest-easy-at-night savings. Ideally, you should have about six months of living expenses put away in savings, money markets or CDs. True, your yield on this bucket will hover around zero, as these vehicles don’t really pay out much. But our objective here is financial safety and avoiding the need for credit cards when life happens.
Income Bucket – In this bucket, contributions are invested in various types of bonds – Treasury, municipal, corporate, high-yield, international and floating rate. Bonds can range from very safe (Treasury) to very risky (high-yield), with yields that vary accordingly. For this reason, you want to maintain a blend of bond types to maximize return while simultaneously protecting your principal. Depending on that blend, the annual yield for this bucket could fall somewhere in the 1% – 6% range.
Growth Bucket — Here is where we get into the “capital appreciation” benefits of owning stock in fast-growing companies (like Amazon) which provide no current dividend income. But as an income investor, you’ll want the majority of the stocks in this bucket to pay dividends.
These types of stocks are often found in one of four categories — consumer staples, utilities, healthcare and telecommunications. Some established tech companies (like Microsoft) and energy outfits (like the Southern Company) provide both growth and income, for a win-win proposition. These stocks have yields somewhere in the 2% – 5% range.
Alternative Bucket – This is a catchall. It contains any asset that isn’t a traditional stock or bond. So, for example, it could include real estate investment trusts (REITs), preferred stocks, master limited partnerships (MLPs) and closed-end funds.
This bucket provides higher current income than stocks and bonds but comes with higher levels of risk. I look at the alternative bucket as your overall portfolio yield-enhancer, as yields from these investments can range from 3% – 8% annually.
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A Final Word on Income Investing
Remember, when I refer to “annual yield” for each bucket, I’m referring to the amount of cash flow that you will receive from the group of assets in that bucket. Your total return will be influenced by price fluctuations of the underlying assets in each bucket. And your overall return will differ depending on the percentage of savings you allocate to each bucket, taking things like your risk tolerance and the time you have to spend in the market into consideration.
Easy enough, right? Of course, once you have your buckets in place, you’ll want to keep regular tabs on their performance. You’ll also want to make adjustments as needed, in response to things like life changes and financial goal fine-tuning. Consider working with a trusted, qualified financial planner to discuss how to fund each bucket and how to maximize potential performance.
An old saying goes, “There are many roads to prosperity, but one must be taken.” Consider building income investing into your financial roadmap. It may lead you to a happier, more financially free retirement.