Product Diversification in an Income Portfolio, Part 1

In the world of investing, we hear of “diversification” as the key to long-term growth with minimum volatility.  When markets fluctuate – up or down – we want stocks that can capture the highs and other investments, which can hold their value during the lows.  Such a well-diversified portfolio may deliver a decent return over the long term.  And that’s what most investors want while saving for the future.

When it’s time to spend the portfolio (i.e., retirement), then “product diversification” is essential to a successful financial future.  An ideal income portfolio has guaranteed savings, a guaranteed income stream (annuity), as well as investments.  The proportions depend on your “risk” situation.  To illustrate, consider the two extremes.

1.  Retirement income that is comprised of 100% equity investments.

In such a scenario, income payments are made by selling units of the investments.  This works well in a rising market because the value of the portfolio grows and if lucky, the growth rate outpaces the redemption rate.

However, in a falling market, the value of the portfolio keeps decreasing and eventually, the payments will run out (known as sequence of returns risk).

2.  Retirement income that is comprised of 100% annuity (guaranteed income stream).

In this scenario, payments simply continue throughout retirement and are unaffected by market movements.  This arrangement offers a lot of peace of mind to the annuitant (one receiving the payments).

But there is a disadvantage of depending solely on a stream of payments for all financial matters.  Life’s expenditures are not so “even”.  It is challenging to meet large expenses and you may be forced to take on debt.  With debt, a portion of the annuity will have to be directed to the principal and interest of the debt leaving less for the annuitant’s day to day living expense.

Ideally, an income portfolio will have some guaranteed fixed income and some investment and savings.  In Part 2, I discuss what product diversification in an income portfolio looks like.