3 Steps to Get More Income From Your Portfolio

MAY 26, 2017

These are still tough times for investment income seekers. Even though the Fed recently raised short-term interest rates—and has signaled more increases are coming—yields for bonds and money market funds remain low by historical standards.

So if you’re nearing retirement, how will you generate enough income from your portfolio?

The answer doesn’t have to involve a lot of fancy footwork, says Rob Williams, director of income planning at the Schwab Center for Financial Research. With the right perspective, a combination of familiar strategies and investments can be an effective way to maximize your portfolio’s income potential.

“You can use a lot of building blocks,” Rob says, “some to help secure your income, some to provide growth. In today’s market, building a broad portfolio is the best approach.”

Step 1: Build in downside protection

Given the volatility in the markets, a smart income strategy should include cash reserves for living expenses—and for downside protection, Rob says. By setting up “buckets” within your portfolio, you can have income when you need it, reduce potential losses and still keep part of your portfolio focused on longer-term growth.

• Set aside 12 months’ worth of expenses, after accounting for other non-portfolio income sources, in a liquid cash account. This reserve is the money you need to supplement your regular income sources, such as Social Security or a pension.

• Keep an additional two to four years’ worth of expenses in short-term bonds or bond funds in case there is a market downturn. With this cushion, you’ll be less likely to have to sell more volatile investments at a loss. (On average, over the last 50 years, it took the S&P 500 about three years to recover from a downturn.)

Having these reserves in place may also help protect you from sequence-of-returns risk. If the market dips early in your retirement, when you’re first taking withdrawals, it can be harder for your portfolio to recover from those losses, increasing the chance that you will run out of money. Having sufficient short-term reserves can help save you from having to deplete your core portfolio.

Another way to add downside protection is to purchase an annuity. An annuity can provide a steady income stream. But the terms, quality and cost of annuities vary widely. Annuity guarantees depend on the financial strength and claims-paying ability of the issuing insurer. It’s best to consult with a financial professional to select an annuity that will suit your specific needs.

Step 2: Focus on growth

With some protection in place, you can now consider investing the remainder of your portfolio in assets that have greater potential to grow, depending on your time horizon and risk tolerance.

Dividend-paying stocks are one option worth looking into, says Brad Sorensen, managing director of market and sector analysis at the Schwab Center for Financial Research, especially given that many equities are paying higher dividends than they have in the past.

“Just remember, these stocks are not a substitute for fixed income,” Brad cautions. But you may want to consider integrating more dividend payers into your equity allocation.

When choosing stocks for income, “look at more than just the current dividend rate,” Brad advises. It pays to examine a company’s cash flow to see if it can continue to cover its dividend. Other factors to consider before buying an income stock include whether the company is selling any assets and how consistently it has offered its current yield over the past five years.

Also be sure to account for broader economic issues, Brad adds. For example, energy stocks could trim their historically impressive dividends because of depressed oil prices. By contrast, financial services and many established tech companies have been increasing their dividends in recent years.

Investors seeking yield may be tempted to consider real estate investment trusts (REITs). These securities invest in income-producing properties and are required by law to pay out at least 90% of their taxable income to shareholders in the form of dividends. But Brad warns that many REITs are sensitive to interest rates, with the asset class as a whole tending to underperform in rising-rate environments.

Step 3: Consider a “total return” approach

Think of the methods above as a way of structuring your portfolio for retirement. When it comes to distribution, one strategy that may help you meet your income needs is the “total return” approach.

Given today’s low-rate environment, it’s not practical for many investors to expect to live on dividends and interest alone, Rob notes. Nor is it necessary to to try, given the other potential sources of return in your portfolio. Consider generating income by selling assets as well.

This approach doesn’t necessarily mean “tapping principal” or “drawing down your portfolio,” which both might sound taboo to some investors. Ideally, a total return approach allows you to harvest some of your portfolio’s gains—including price appreciation—for income. Depending on how much you withdraw, your portfolio may continue to grow.

Often, the routine process of rebalancing presents the ideal time to sell assets and harvest gains. Rebalancing involves selling the securities (stocks, bonds, etc.) that have grown beyond their percentages in your asset allocation plan due to the relative gains and losses across your portfolio. By selling the outsize positions, you can reallocate to your targets, help manage your risk exposure and add to your income stream.

You may want to enlist the help of a professional to decide which investments to buy and sell to bring your portfolio back in line with your plan and generate the income you need.

If you structure your portfolio to include short-term reserves and income-producing equities—as well as considering total returns in your distribution strategy—we believe it’s possible to maximize your portfolio’s income-generation potential without being held captive to low interest rates today.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

All annuity guarantees are subject to the financial health and claims-paying ability of the issuing insurance company. Neither Schwab nor its affiliates provides insurance guarantees. Unlike a CD, which is an FDIC-insured bank product, an annuity’s payment guarantees are provided by and only as strong as the financial position and claims-paying ability of the issuing insurance company. Schwab does not provide any insurance or other guarantee. Consult the insurance company’s ratings for its financial strength, and read the annuity contract and/or prospectus before investing. Insurance company ratings do not apply to the performance of variable subaccounts. Ratings are subject to change. There is no guarantee current ratings will be maintained.

Charles Schwab & Co., Inc., a licensed insurance agency, distributes certain life insurance and annuity contracts that are issued by non-affiliated insurance companies. Not all products are available in all states.

Rebalancing and diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The information presented does not consider your particular investment objectives or financial situation (including taxes), and does not make personalized recommendations. Any opinions expressed herein are subject to change without notice. Supporting documentation for any claims or statistical information is available upon request.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

Past performance is no guarantee of future results, and the opinions presented cannot be viewed as an indicator of future performance.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

© 2016 Charles Schwab & Co., Inc. All rights reserved. Member SIPC.