Lesson 2: Investing For Growth, Income Or Safety

Investing For Growth, Income Or Safety

November 26th, 2011 by

defining your income needsWhat are you looking to get out of your investments? Immediate income, capital appreciation, income at a later date or some mixture of all three?  To determine the level and type of return that you want from your investments, you can think about the same characteristics that you did when looking at risk:

Age

When you are in your peak income generating years (30s – 60s), you probably don’t need to generate additional income from investments. Therefore, a larger portion of your portfolio should be in growth investments, like stocks. As you move towards your later years, most people will shift more of their portfolio into bonds and other fixed income products.  These investments will generate the income they need for living expenses when they are no longer earning a salary.

Capital preservation also becomes more important as people age.  During retirement a person’s income is primarily determined by the interest they can earn (which is up to the market) and the amount they can invest.  Loosing or having to dip into your portfolio to pay day to day living expenses can create a vicious cycle.  As your portfolio gets smaller it generates less income, requiring you to dip into your investments further, which again lowers the income your portfolio is producing.

Goals and Time Lines

Projects like buying a house may be better served by selecting zero coupon bonds or CD’s that mature around the time you want to make the purchase. If you are saving for your child’s education expenses you may want to start with investments such as stocks which have a higher risk and return profile, and then shift gradually to fixed income products as your child grows.

When investing money that you will need in a lump sum at a specific date in the future, bulleting is a popular strategy.  A bullet involves periodically purchasing bonds which all have the same maturity date.  Because the maturity date is the same for all the bonds you get all the money you have invested back at the same time.  Because the purchase dates are spread out, you avoid potentially investing all your money when interest rates are at a relative low point and missing out on the additional return as interest rates rise.

Current Revenues Versus Expenses

If you’re already earning enough to cover all your expenses, then you’ll have the flexibility to pursue whichever investment style you want. If not, you will need to focus on capital preservation and income.

Be careful not to confuse income from bonds with cash flow requirements. Cash flow is the money you need to cover all of your expenses, including taxes. Income from fixed income products is usually taxable. In that case, some of the income you receive has effectively already been spent. Bond income will therefore need to exceed cash flow requirements.

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