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Income strategies vs. investment strategies

By Alan Klayman

Maturing Loans
Alan Klayman, creator of MyIncomeStrategy.com, is CEO of Klayman Financial LLC. He served as a vice president at Fidelity Investments, worked as a financial planner for American Express, and built fixed income strategies on Wall Street at The First Boston Corporation.

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Question for the CreditCards.com expert

Dear Maturing Loans,
You keep saying not to rely on investments as part of retirement income, but to create an income strategy. What exactly is an income strategy, how does it work and why is it better to generate income from that instead of your typical investments? -- Samuel

Answer for the CreditCards.com expert

Dear Samuel,
We discussed the difference between an income strategy (getting money from your savings and investments) and an investment strategy (ways to grow money) in last week's column. We discussed how the math was different, and how important it is to put strategy first, then pick investments.

We also said that we would look at some specific examples of investments and investment strategies, along with income and income strategies. This will help you distinguish the difference.

Keep in mind that the information contained in this column is for information purposes only and does not constitute investment, legal, tax or other advice. Before making any investment decision, you must consider your particular investment objectives and financial situation and are encouraged to consult with your broker, planner or other financial or tax adviser.

These examples given are illustrative, and are not representative of any particular individual's situation.

Investment strategy example
You have $100,000 to invest, don't want to take a lot of risk, but want to give yourself a chance to grow the money in the stock market. How can this be done?

One way is using what is called an anchor strategy. Here is how it works:

Step 1) At the time of this writing, some 10-year AA corporate bonds are paying 6 percent. If we take $56,000 today to invest at 6 percent over a 10-year period, you will have $100,000. Do you have to use corporate bonds? No. You can use bank CDs, government and municipal bonds, fixed deferred annuities, and many other types of fixed instruments. You are not using stocks or mutual funds (this includes bond funds). Please see your financial professional for the investments that are suitable for your situation.

Step 2) Take the remaining $44,000 and invest it. Here are three scenarios:

Scenario 1:
You invest in high-risk securities and lose it all. Your $44,000 is worth $0 then after 10 years. You have $0 (from step 2) plus $100,000 (from step 1) equals $100,000, which means that after 10 years, you have your $100,000 with a 0 percent return.

Scenario 2:
You invest in anything (stocks, bonds, funds) and wind up earning 6 percent. So, your $44,000 now equals $78,000 after 10 years, and you end up with $100,000 (from step 1) plus $78,000 (from step 2) equals $178,000. Your rate of return is 6 percent for the entire $100,000 over 10 years.

Scenario 3:
You take risk (like in Scenario 1), but end up earning 11 percent (your risk paid off!). Now your $44,000 investment equals $124,000 over 10 years. You end with $100,000 (from step 1) plus $124,000 (from step 2), which equals $224,000. Your rate of return is 8.4 percent for the entire $100,000 over 10 years.

Is this the only way to try to grow this money? No. This was just an example to illustrate one type of investment strategy.

Income strategy example
A retiree has pensions and works part time. Her Social Security doesn't start for another seven years. She needs an additional $750 a month ($9,000 a year) from her retirement savings of $200,000 until Social Security kicks in. Plus, she wants to cover for inflation. How can she do this?

One way is to use a seven-year, 'spend down and grow back' strategy. Here is how it works:

Step 1) The retiree can put approximately $55,000 somewhere to try to guarantee income for seven years. For example, she may invest in a bank CD ladder. In this example, the retiree would first take $9,000 from the $55,000 and keep it in a money market account and use it for income in year one. Then she would place enough money to have $9,000 come due in a one-year bank CD, a two-year bank CD, and a three-, four-, five, and six-year bank CDs -- all with $9,000 coming due each year. When the CDs come due, the retiree would place the money into her money market account and use it for income.

Step 2) The retiree can then take the remaining $145,000 and place it in a well-diversified portfolio (mutual funds, stocks, bonds, or an account that can be managed by a professional). She needs to earn 5.64 percent on her $145,000 to grow back the original $200,000, plus 3 percent inflation to replace the $55,000 she spent over the first seven years. What if she earns more than 5.64 percent? Then she has more money, and possibly more to use in the future. What if she earns less than 5.64 percent? Then she has less money and needs to adjust her income expectations in the future.

In this example, the investment strategy used in step 2 of this income strategy is of paramount importance. Taking too much risk can put your entire income at stake in the future.

An example of this seven-year strategy is on my website.

Is this the only way to get income over a seven-year period of time? No. There are many types of income strategies and you need to find what works best for you.

A big question people ask when it relates to an income strategy is: How do I find what works best for me?

I suggest you do research, and speak with a financial professional. To get you started on the path of finding what works best for you, I've developed a strategy selector tool that you can use for free.

To sum up, income strategies help you plan out how you will receive your income from your investments. Investment strategies help you best utilize those investments to take on the tasks that you assign them.

See you back here next week to answer more questions. 

Ask a question. 

Alan Klayman is creator of MyIncomeStrategy.com and CEO of Klayman Financial LLC. Klayman specializes in retirement income planning, business management and planning, estate planning, tax-advantaged investing, trust investment management, professional money management, insurance and annuities, mutual funds, fixed income securities, and institutional and personal retirement plan administration.

Published: May 28, 2008


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