4 Best Retirement Investment Options for 2023

In the United States, reaching the age of 65 typically corresponds to an average life expectancy of around 85 years. But this number represents just the midpoint in a spectrum of possibilities. Surprisingly, approximately one in every three individuals who reach age 65 today will go on to celebrate their 90th birthday, while one out of every seven will even reach the age of 95. This presents a significant challenge for those who plan to retire in their 60s, a common choice among many. In such cases, they must ensure that their retirement savings can endure for nearly three decades – a substantial burden to place on a traditional retirement account.

Social Security retirement benefits, though a critical part of many retirees' financial plans, only replace about 40% of their pre-retirement earnings. To maintain financial stability during retirement, individuals need to supplement these benefits through pensions (if available), personal savings, or investments.

In particular, Social Security tends to be more impactful for lower-wage earners. For example, for someone earning $50,000 annually, Social Security benefits will only replace approximately 33% of their pre-retirement income. Consequently, there's an imperative to cultivate additional income sources that can help meet the rising costs of living, health care, and other expenses during retirement.

While staying active and engaged in communities can be rewarding both financially and mentally, it remains vital to have a well-structured plan for generating supplementary income during retirement. Ensuring that these future income streams keep pace with inflation and increasing living expenses is paramount.

Many individuals are recognizing the significance of constructing a retirement income strategy that balances portfolio stability with competitive income generation, especially in today's environment of fluctuating interest rates. As Rob Haworth, senior investment strategy director at U.S. Bank, points out, "People are realizing that they can reduce volatility in their portfolio while generating more competitive income in today’s interest rate environment." Consequently, in light of the shifting interest rate landscape, prospective retirees are reassessing their investment options.

Before we dive deeper into the 4 best investment options to help generate retirement income we need to understand the retirement needs:

Understanding Your Retirement Needs

Before diving deeper into the specifics of investment options, it's crucial to assess your retirement needs. It involves a comprehensive assessment of your financial goals, risk tolerance, and time horizon, all of which play a pivotal role in shaping your retirement investment strategy. Start by asking yourself:

What are Your Financial Goals?

Your retirement goals are the foundation upon which you build your investment plan. These goals can vary significantly from person to person. Some individuals may aspire to live a lavish lifestyle during retirement, traveling the world and enjoying various leisure activities. Others might prefer a simpler, more frugal retirement, focusing on spending time with family and pursuing personal interests. By clarifying your financial goals, you can determine how much income and capital you'll need to support your desired retirement lifestyle.

How Much Risk Can You Tolerate?

Your risk tolerance is your willingness and ability to withstand market volatility and potential losses in your retirement investments. It's a critical factor because it influences the asset allocation within your portfolio. If you have a high risk tolerance, you may be comfortable with a more aggressive investment approach, such as allocating a larger portion of your portfolio to stocks. On the other hand, if you have a lower risk tolerance, you may prefer a more conservative strategy with a higher allocation to safer assets like bonds or cash. Understanding your risk tolerance helps you strike a balance between potential returns and the protection of your retirement savings.

What's Your Time Horizon?

The time remaining until your planned retirement date is another key consideration. A longer time horizon typically allows for more investment flexibility and the ability to recover from market downturns. If you have several decades until retirement, you may have the opportunity to take on more risk in your portfolio, potentially aiming for higher returns. Conversely, if you're nearing retirement, you may prioritize capital preservation and income generation over aggressive growth.

Now let's consider four common investment avenues for generating income in retirement, categorized generally from lower to higher risk. Each choice offers a unique balance between potential returns and risk tolerance, allowing retirees to customize their investment strategy to meet their specific financial needs and objectives.

1. Income Annuities:

Income annuities represent a contractual agreement between you and an insurance company, designed to provide financial stability during retirement. With these annuities, you make either a lump sum payment or monthly contributions in exchange for regular income payments. This can be a powerful tool to establish a guaranteed income stream for a predetermined period or even for the entirety of your life. Moreover, you can opt for income that continues through your lifespan or extends to another beneficiary, such as your spouse.

The funds you commit to an annuity are held by the insurance company and can accumulate on a tax-deferred basis, potentially increasing the value of your investment. When you decide to start receiving disbursements, you have the flexibility to choose a fixed dollar amount or one that adjusts for inflation. Determining the most suitable annuity type for your unique circumstances often requires the guidance of a financial expert.

Annuities serve as a valuable component of retirement planning, offering safety, long-term growth potential, and a dependable income source. Many retirees turn to annuities to complement other guaranteed income sources, such as Social Security, enabling them to cover essential expenses. As they provide income guarantees, annuities act as a protective shield against the risk of outliving your retirement savings.

The advantages of annuities are:

• Steady Income: Regardless of market fluctuations, annuities provide a steady and predictable income stream throughout retirement, contributing to financial security.

• Tax Benefits: They offer tax-deferred growth and tax-advantaged income, optimizing the value of your investments.

• Flexibility: Annuities grant flexibility in both saving for retirement and receiving funds, aligning with your changing financial needs.

• Beneficiary Benefits: In the event of your passing, annuity payments can continue for your beneficiaries, ensuring ongoing financial support for loved ones

  However, it's essential to acknowledge the challenges associated with annuities as well:

• Underlying Company's Financial Health: The guarantees offered by annuities are contingent on the claims-paying abilities of the insurance company backing them. Consequently, it's crucial to choose a reputable, financially stable insurer.

• Limited Liquidity: Annuities may have restricted liquidity, making it challenging to access your funds before the agreed-upon distribution date.

• Early Withdrawal Penalties: Withdrawing funds from annuities before reaching age 59½ could result in a 10% tax penalty, discouraging premature access.

• Risk Consideration: The risks associated with annuities can be heightened if the issuer is not a highly-rated insurance company, emphasizing the importance of selecting a trustworthy provider.

2. Diversified Bond Portfolios for Income in Retirement:

Historically, bonds were not the first choice for retirees seeking income, but recent shifts have breathed new life into this investment avenue. As the Federal Reserve hiked short-term interest rates, bonds regained their appeal. Consider this: at the outset of 2022, a 5-year U.S. Treasury note yielded a modest 1.37%, but by the end of May 2023, the yield had surged to 3.74%.

Bonds come in various forms, offering retirees a wide spectrum of options. You can opt for individual bonds, including U.S. Treasury securities, municipal bonds, corporate debt instruments, government entity bonds, mortgage-backed securities, or bonds from international markets. Yields vary, influenced by the issuer's credit quality, the bond's maturity duration, and prevailing market conditions. Many retirees choose bond mutual funds, which provide a professionally managed, diversified portfolio comprising bonds from different issuers.

Bonds offer several advantages:

1. Steady Income: Bonds provide a consistent income stream with potentially competitive yields.

2. Liquidity: They offer flexibility for timely portfolio adjustments.

3. Diversification: Bonds grant access to a diverse range of fixed-income instruments with varying yields and risk profiles.

4. Risk Mitigation: They can effectively diversify a portfolio that includes equities and other asset classes, helping offset overall risk.

However, bonds also present challenges:

1. Taxation: Except for tax-free municipal bonds, bond income is subject to taxation at ordinary income tax rates.

2. Principal Risk: If interest rates rise and you need to sell the bond, you face the risk of losing principal.

3. Income Replacement: It can be challenging to generate comparable income in the future when replacing maturing bonds, especially in a changing interest rate environment.

4. Inflation Protection: Bonds may lack inflation protection as the income streams they establish remain consistent over time.

Key Points to Consider

With people living longer lives, it's essential to plan for the possibility that your retirement savings may need to cover expenses for 20 years or even longer.

If you're approaching retirement or already retired, there are various investment options like bonds, annuities, and income-generating stocks that can provide extra income alongside Social Security, pensions, savings, and other investments.

Seeking guidance from a financial expert can assist you in identifying the most suitable strategy for generating retirement income tailored to your unique circumstances.

3. Total return investment approach:

A total return investment approach offers a comprehensive strategy for generating income from your investment portfolio, encompassing various income sources such as interest, dividends, and capital gains. This approach is predicated on the concept of "total" return, which involves utilizing a portion of the average annual rate of returns — comprising both income and appreciation — over an extended timeframe, typically spanning 10 to 20 years. Rather than fixating on specific annual return rates or solely relying on income generated by portfolio holdings, the total return approach focuses on the overall growth and performance of the portfolio. The ultimate goal is to ensure that this cumulative return adequately meets or exceeds your withdrawal rate.

Rob Haworth, senior investment strategy director at U.S. Bank, highlights the significance of this approach, stating, "This is a strategy to increase a retirement portfolio so that it keeps providing for the needs of persons preparing for retirements that could last 20 to 30 years or longer. Comparing this strategy to more traditional retirement investment plans, investors may be able to attain a higher overall return."

In the context of withdrawal rate management, a total return approach adheres to a systematic withdrawal plan in which a predetermined percentage of your portfolio's total value is withdrawn as income each year. Typically, this distribution rate falls within the range of 3% to 5% of the total portfolio value.

The advantages of a total return approach are multi-faceted:

1. Meeting Immediate Cash Flow Needs: It enables you to address your immediate cash flow requirements while concurrently building savings to cover future expenses. This is particularly important as expenses are prone to increase over time due to inflation.

2. Diversified Asset Utilization: Unlike more traditional retirement income strategies, the total return approach allows for the utilization of a broader spectrum of assets. This diversity can enhance portfolio resilience and adaptability.

3. Tax-Efficient Income: A significant portion of the portfolio withdrawals may stem from capital appreciation, potentially resulting in a more tax-efficient form of income distribution.

However, it's essential to acknowledge the challenges associated with the total return approach:

1. No Guarantee of Fund Longevity: There is no assurance that the funds will last throughout your entire retirement, especially when unexpected financial needs or market downturns occur.

2. Variable Returns: The annual portfolio return can fluctuate, as there is no fixed withdrawal rate. The actual income generated can vary from year to year based on market performance.

3. Exhaustion of Assets: In certain circumstances, such as a prolonged market downturn, assets may deplete before the conclusion of your retirement, necessitating careful monitoring and contingency planning.

4. Income-producing equities:

Income-producing equities play a significant role in diversifying investment portfolios and providing a consistent income stream. While the primary objective of investing in stocks is typically capital appreciation, certain equities offer income through dividends. Publicly traded companies often share their profits with shareholders in the form of dividends, although it's important to note that not all stocks pay dividends, and the dividend yield can vary.

Rob Haworth, senior investment strategy director at U.S. Bank, highlights the appeal of dividend-paying stocks, particularly during periods of low interest rates in the bond market. While bond yields have historically been a go-to for income-seeking investors, dividend yields from many stocks still offer potential for capital appreciation.

Typically, companies distribute dividends on a quarterly basis, providing investors with a regular income stream. However, it's crucial to understand that unlike most bonds, dividend payments from stocks can fluctuate between payout periods. There is also the risk that companies may decide to discontinue dividend payments, introducing an element of uncertainty for investors relying on these income streams.

For investors seeking income from stocks, it's advisable to examine a company's dividend history. Stocks with a track record of consistent or steadily increasing dividend payouts tend to be more attractive for income-focused investors.

Beyond individual stocks, publicly-traded Real Estate Investment Trusts (REITs) represent another avenue for income-producing equities. REITs are corporate entities that own, operate, or finance income-generating real estate properties. These publicly-traded REITs are listed on major stock exchanges, making them accessible for investors who want to add real estate exposure to their portfolios. However, it's essential to understand that REIT prices can fluctuate daily, influenced not only by the underlying value of the real estate assets but also by broader market conditions.

Income-producing equities offer several advantages:

1. Regular Income: They provide a consistent income stream generated by companies with strong earnings and a history of reliable dividend payouts.

2. Capital Appreciation: Investors can benefit from the potential for stock price appreciation alongside the income generated.

3. Built-in Return: Dividend income provides a built-in return on equity investments, irrespective of the stock's price performance.

4. Diversification: Publicly-traded REITs can diversify a portfolio primarily composed of stocks and bonds, offering a diversified income source.

However, it's important to be aware of the challenges associated with income-producing equities:

1. Higher Volatility: These equities can be subject to more significant price fluctuations compared to traditional income vehicles like bonds.

2. Inconsistent Dividends: Not all companies maintain a reliable track record of dividend payouts, introducing uncertainty for income-seeking investors.

3. Interest Rate Sensitivity: Rising interest rates can make stock dividends less attractive compared to other income options.

4. Tax Considerations: Dividend income is typically taxed at higher ordinary income tax rates, which can impact overall returns.

Choosing the ideal retirement investment strategy necessitates considering your risk tolerance and time horizon. A financial advisor can provide valuable insights into these options and assess their suitability for your retirement income plan. Investing time in comprehending your choices and evaluating your financial situation empowers you to approach your retirement years, whether you're entering them or are already retired, with increased financial confidence.