Income stocks and other assets have a place in your portfolio during certain stages of your life, generally when you need income or stability. Income stocks are more stable than growth stocks because their return is more certain. The markets may stagnate, causing returns from appreciation to be very low or even negative for the year. Because income stocks pay a steady dividend, however, you can get a return on your investment even when the markets are going nowhere. The time when this makes the most difference is when we have a long period – maybe 3-5 years– where the markets really go nowhere. Holding income stocks will put you ahead of the game when the markets do finally turn around.
Another reason for holding income stocks is just what the name implies: income. If you need income for expenses, it’s nice to have a dividend paid out four times a year, or interest from a bond paid out twice a year. If your portfolio is large enough and interest rates are high enough, you can setup a portfolio of income stocks and bonds such that you have the money in your money market account right when you need it for your yearly expenses. You just stagger the dividend and interest payments to receive income when you need it based on your bills.
Normally you would use a portfolio of income stocks if you were in retirement. It can be used for other purposes, however. For example, if you had a son or daughter going off to college, you could send them with a portfolio of income stocks and bonds designed to provide the money needed when tuition bills and other expenses were due. If necessary (because the portfolio wasn’t large enough to sustain itself) they could also sell off some shares as needed to generate additional income. When they were ready to graduate, they could use whatever was left over of the money you gave as a starter portfolio, an emergency fund, and probably a down-payment on a house. Note that you would need to start building up this portfolio when they were 15 or 16 by starting an account for them and transferring funds and stocks into it since you would be limited to how much you could transfer without paying gift taxes.
Creating a portfolio for your children is often better from a tax-standpoint, but you also might have a child that spends all of the money you’ve set aside for college on other things. After they turn 18, the portfolio becomes theirs and they can do what they choose. Another option would therefore be to buy income stocks and bonds in your portfolio and use income from them to pay tuition and living expenses for them directly. You could also do something like provide a couple of year’s worth of expenses in a portfolio for them, then continue to add to it if they handle their money wisely. The chances of being able to pay for things from income from the portfolio alone in that case, however, would be low since the account value would be smaller.
A final reason for holding income stocks is to reduce the risk of a serious loss. Basically, you have grown your portfolio to a certain point and want to avoid suffering a major setback. Because the dividend payments tend to support the price of income stocks, and because bonds eventually are repaid by the company if they are still in business when the bonds come due, income stocks and bonds are safer that growth stocks. It isn’t a bad idea to put a portion of your portfolio into income as you make some sizable gains and want to protect them.
Income stocks and bonds are not the best choice when you’re young and trying to grow money. The returns will be lower over long periods of time for a basket of income stocks than that from a basket of growth stocks, plus you’ll be paying taxes on the income each year. If you do want to hold bonds and income stocks before you need the income and just reinvest, because, perhaps, you are willing to sacrifice return for fewer fluctuations in the value of your portfolio, it would be wise to put them into and IRA or a 401k where they would be sheltered from taxes and keep mainly growth stocks in your taxable portfolio.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.