In Ecclesiastes, the Bible tells us that “to every thing there is a season.” The season of retirement is famously a time for preservation of capital and maximization of income, not for aggressive risk-taking. Some options, like savings accounts and Certificates of Deposit, emphasize preservation of capital to the exclusion of almost all else, trading rates of return that can be charitably described as minimal for the absence of risk. Investors who are willing to exchange even a small measure of safety for significantly more attractive returns can take advantage of several other investment vehicles.
In the equities markets, stocks that pay dividends provide an opportunity to receive relatively predictable income while retaining the possibility of appreciation in share price. Dividends are most heavily represented in that bastion of conservative investment, the shares of utility companies, but stocks that pay dividends can be found throughout the equity spectrum, especially among companies that offer preferred stock. A company’s equity offerings can be split into several classes of shares, including common stock that carries no dividend and preferred stock that is dividend-paying. Common stock tends to be more volatile than preferred, as its price is not supported by a specific yield, but any share price can change over time. Thus, investors can evaluate a stock in terms of its yield, with a higher yield representing a bigger dividend in comparison to the underlying price of the stock.
Companies with stable and highly predictable cash flow, like utilities, are over-represented among the best dividend stocks because the reliability of the dividend is a key concern of investors. Even utilities can see their cash flow change, however, and companies typically make an annual declaration of the dividends they will pay for the coming year.
Bonds are similar to dividends in that they promise regular income. The simplest example of the underlying theory is the United States Savings Bond, which is purchased at a discount and redeemed in the future for full face-value. The difference between the bond’s initial price and its redemption value can be expressed as an interest rate, the percentage that is added to the bond’s value each year as the bond matures.
A bond is essentially a loan to the issuer of the bond. Interest rates naturally vary depending on the issuer’s solvency, with the lowest rates attaching to bonds backed by the federal government and higher rates attaching to the bonds of less stable issuers. Rates are also time-sensitive. A bond that is to be repaid in 30 years will generally pay more interest than a bond with a term of three years in order to induce investors to tie up their money for longer periods. In addition, bonds issued by some governmental agencies may carry a lower rate but provide interest income that is tax-free.
Both bonds and dividend-paying stocks may be purchased individually, but they are also available through specialized mutual funds that limit their investments to those segments of the financial market.
Unlike stocks and bonds, annuities are not a publicly traded investment. Instead, they are contracts with insurance companies that guaranty a stream of income over a set period of time or for the investor’s lifetime. The investor deposits a lump sum with the company or makes periodic payments to fund the annuity, and those funds earn interest while accumulation continues. In the future, the company repays the investor in an amount and on a schedule determined by the particular annuity contract.
Fixed annuities are among the least risky and most predictable of investments. For better or worse, they are not subject to the fluctuations in value that can affect stocks and bonds for better or worse. In addition, a “single life” annuity can alleviate the risk that an investor will outlive his or her income by promising a reliable stream of income for life, an attractive investment feature at a time of increasing longevity.
This article was submitted by Ramsay, author of the dividend stock blog and creator of the top dividend stocks service.