It can be difficult at times to invest money safely when living on a fixed income. Safe products, like money market funds and certificates of deposit, are barely keeping up with inflation, and longer-term bonds are being threatened by the potential of continued interest rate increases by the Federal Reserve. Here’s a look at some strategies that might allow fixed-income investors to earn more while protecting their fixed budget, as well as what to avoid, as recommended by the financial experts at CNBC.
What to consider
- Short-term bonds: Consider a diversified portfolio of short-term bonds or short-term municipal bonds, depending on your tax bracket. Short-term bonds pay higher interest rates than money markets or CDs, and they will typically lose very little principal when compared to longer-term bonds if interest rates should go up.
- Fixed annuities. These financial products currently guarantee a minimu return of 2.5% to 3.5%. They also tax-deferral on income, making them even more valuable for taxable investment accounts. Fixed annuities won’t lose principal should interest rates go up.
- Large U.S. corporation paying dividends. Another avenue to consider is collecting dividends from high-quality, large multinational U.S. corporations. Look for consistent increases in dividends for 10 to 20 consecutive years. These stocks are very large, and they dominate their markets. These companies are not going bankrupt and will be around for a very long time. A diversified portfolio paying out 2-3% in dividends annually will go a long way in supplementing the lower income received on fixed-income investments.
What to avoid
- Long- or intermediate-term bonds. Short-term bonds (less than three-year durations) are a better option. If interest rates go up, longer-term bonds will lose too much principal.
- Balanced funds. These funds hold about 40-60% bonds, with average maturities of 8-12 years. Therefore, half of the investments in these funds will lose money as interest rates go higher.
- Target-date funds. Target-date funds are typically misunderstood by investors. They are marketed as an investment that will automatically be adjusted to be less and less risky as the investor approaches to retirement. In reality, in order to make the funds less risky, they invest more of the fund’s portfolio into bonds (8-12 year maturity). With the very likely possibility that the Fed will raise interest rates, these funds are becoming riskier the closer investors get to retirement.
The current economic environment makes it a bit difficult for fixed-income investors to find safe income, but keep in mind that we have very low inflation right now. This means that it’s not necessary to get 5-6% interest on your fixed-income investments. If you’re living on a fixed income, it is important to maintain the purchasing power of your savings. Keep in mind, getting a 3% return when inflation is 1% is the same as getting 6% when inflation is 4%, in terms of purchasing power that is.
Written by Rachel Summit