Investment Vehicles
Typically, I look at a combination of several investment vehicles, including:
- Stocks
- Mutual funds
- Bonds (including bond mutual funds)*
- REITs (real estate investment trusts)
- Annuities
- Money market funds
We tend to use individual stocks only when a client has a substantial portfolio to handle the added risk. The idea is to take advantage of the greater diversification in an equity mutual fund and the expertise of a fund manager. Stockbrokers typically do not manage individual stocks with the same intensity as a fund manager. Equity mutual funds allow for much greater diversification and reduce the degree of risk.
Mutual Funds
The first equity mutual fund was established as far back as 1924 and consisted of 45 stocks. It wasn’t, however, until the 1990s that mutual funds became the rage and fund managers became as popular, in some circles, as baseball stars. While the economic downturn of the past several years has taken the shine off the rosy picture of mutual fund madness, they should still remain a key component in your retirement portfolio.
Mutual funds, in short, are the sum of their many parts, which are the individual stocks within the fund. The fund manager does the buying, monitoring, and selling of the various equities, making your job much easier because you need only select the type of fund that best meets your needs.
- Benefits of mutual funds include:
- Instant diversification (by owning many stocks)
- Professional fund management
- Ease of purchasing
- Lower risk than individual stocks
A mutual fund also allows you to buy into many stocks with one payment, stretching your dollar further than you could by purchasing individual stocks. For example, a $10,000 investment in one mutual fund can buy you 200 stocks, where purchasing each stock individually would cost significantly more money and be far more difficult to monitor.
Within the mutual fund arena, there are many variations on the overall theme. There are literally thousands of funds to choose from, and a good advisor is worth his or her weight in gold if he or she can narrow the field down to the ones that are best suited for your needs.
Mutual funds, like stocks, are an investment that fluctuates with market conditions, and they do involve risk. Investment returns and principal value will fluctuate just as stocks do.
Making Bonds* Work for You
For our purposes, we use bonds to help generate income. The types of bonds will depend in part on your income needs, as well as your risk tolerance and the current rates. Like equity mutual funds, bond funds* can provide diversification. However, because bonds are typically less volatile and are easier to predict than stocks, bonds can be bought individually for your portfolio, with the guidance of a financial advisor.
As people approach retirement, the security of bonds often becomes more attractive. Diversification (between various types of bonds) is still recommended, as is always the case when investing.
You will also need to consider the different ways in which bonds pay interest. Fixed-interest bonds pay the same steady amount of interest and do not fluctuate. Bonds with variable interest rates, however, will fluctuate. Variable interest rates may be affected by the economic conditions, exchange rates, and the stock market. Historically, the bond market will do well when the stock market does worse, and vice versa.
The interest from bonds provides your base retirement income coupled with Social Security and any other steady avenues of income, which might also include a monthly payout from a pension plan. One thing you need to be aware of with bonds is that their underlying value will fluctuate. But because we are buying bonds for the income they generate and not for their potential appreciation, the day-to-day fluctuations in value do not concern us greatly.
While many retirees move into new jobs or start new business ventures, it is typically best to focus primarily on bonds as the main source of steady income for your retirement portfolio. If you start a business that does well and provides income, you’ll then have the very pleasant dilemma of figuring out what to do with the extra income. In the meantime, you should work within the three bags as outlined in "Income Streams".