I'm 64 and retired. Which types of mutual funds should I invest in to earn income?
Investing during retirement is tricky business indeed. While a young investor has years to make up for poor investment decisions, an error in judgment could be devastating for a retiree.
We'll give you some investing advice in the paragraphs that follow, but if you're concerned about your cash flow during retirement, we also suggest that you visit a financial planner to make sure you're on track. After all, the stakes are high.
The first thing you need to consider is your asset allocation. A common mistake made by recent retirees is to be overly conservative by investing too heavily in bonds. These days, a 65-year-old person could easily spend 30 years or more in retirement, which means that at least part of his or her portfolio should be invested for growth, says Fran Kinniry, principal of investment counseling and research at fund firm Vanguard.
So just how much should remain in equities? One way to get a rough approximation is to subtract your age from 110, says Tom Roseen, a research analyst at mutual-fund tracking firm Lipper. So someone age 64 could shoot to have a little less than half of his portfolio held in stocks. That, of course, is just a broad estimation. The correct asset allocation for a specific individual depends on numerous factors, including estate-planning goals, economic outlook, portfolio size and the other sources of retirement income he or she may have, such as a pension and Social Security. To get a sense of the right asset allocation for you, check out our Asset Allocator for Retirees.
Now, on to the heart of your question: Which funds should you be looking for to generate income? First, let's talk bonds. When considering bonds, one of the first decisions to make is whether to hold individual bonds or bond funds. Given that an individual bond has a fixed maturity and interest rate while a bond mutual fund does not, these are two slightly different beasts. (For more on this, click here.) We generally recommend that investors hold a laddered portfolio of individual Treasury bonds (which offers some protection from rising interest rates) rather than one or more Treasury bond funds. But investors looking to hold more exotic corporate or municipal bonds might be better served by investing in solid bond funds with experienced managers at the helm.
The equity portion of your portfolio can be invested for income as well. Focus on income-generating funds that have higher distribution payouts, such as utility funds or real-estate investment trusts, also known as REITs, Roseen says. You might also consider conservative equity-income funds, such as Vanguard Equity Income (VEIPX), which provide a diversified portfolio of dividend-paying stocks. (For more on these sorts of funds, click here.)
When you rebalance your portfolio to generate more income, keep in mind that the new tax law changes could affect which holdings should be kept in a taxable account and which in a tax-advantaged account. As you may know, under the new law, qualified dividends will now be taxed at just 15%, rather than the ordinary income rate, which runs as high as 35%. Long-term capital gains also will be taxed at a rate no higher than 15%. For more on this, click here.
Thanks to these new rules, assets that generate ordinary income (which isn't subject to any new tax break) — such as the interest payments generated by bonds, and REIT income — are probably best held in tax-deferred accounts, such as an IRA or a 401(k). On the flip side, it could be wise to hold investments that generate dividend income or a long-term capital-gains hit in a taxable account, since the rates are now so low. For more details on tax-smart investment moves, read our story.
Finally, unless you have a very large portfolio, chances are you're going to have to tap into some of your principal each year — or at least during those years when then the market underperforms. That's not necessarily a bad thing, although it's important to figure out the maximum amount you should withdraw each year. (Click here to get a basic estimate of how long your money will last.) Keep in mind that as you get older, you'll continue to have to shift to a more conservative allocation, which means the income your portfolio will earn will probably shrink.
Worried that your portfolio might not be big enough to generate the income you need? You're not alone. Many retirees are now rethinking retirement, and looking for ways to continue to earn a small income by working part-time. Not only is this a great way to stretch out your retirement savings, but in some cases, it can be personally rewarding as well.