Treasurys typically deliver a relatively low rate of return but are considered among the safest of income-generating investments because they’re backed by the U.S. government, Diczok says. Depending on the type of Treasury instrument you buy, maturities range from four weeks to 30 years. Typically, the longer the maturity, the more interest the bond pays. But also be aware that longer-maturity bonds, and especially Treasurys, are more sensitive to interest rate risk. When rates go up, the value of the bond goes down. That’s of less relevance if you plan to hold it to maturity, but you might want to ask yourself: Am I sure I won’t need the money before then?
Municipal bonds are offered by state and local municipalities, and the income they generate is usually exempt from federal income taxes. “The trade-off for this federal tax-free status is a relatively modest rate of return,” says Diczok. “This is why it’s helpful to compare the after-tax return of other bonds with the interest you receive from municipals.”
Investment-grade corporate bonds are issued by private companies with high credit ratings. They are generally less volatile than the stock market and offer higher rates of interest than Treasurys or municipal bonds, according to Diczok, but because they’re backed by companies rather than the government, they’re considered somewhat riskier.
High-yield bonds generally deliver higher returns than investment-grade corporate bonds but are considered riskier. Diczok warns that their price might fluctuate in a manner closer to that of stocks than of bonds with a less risky profile.
3 more tactics that can help you invest for income
Build a bond ladder. It’s one of the most popular income-producing strategies and, as Diczok notes, can work in any type of interest rate environment. You can create a ladder by investing in a mix of bonds with short, medium and long durations. All bonds have what’s called a maturity date, which is the day that the full value will be paid back to you, the investor. “Most income investors want regular, reliable payments, which means owning a range of different maturities,” says Diczok. Doing so gives you predictable payments and the option to reinvest at current market rates as each bond matures. Plus, laddering helps to increase liquidity, says Diczok. The shorter-term bonds you purchase will offer access to cash as they mature, should you need it to supplement your income sooner rather than later.
Streamline your investing by using funds. “The most cost-efficient way to build an income portfolio for the average investor may be through ETFs and mutual funds,” says Diczok. “These funds can give you access to a range of securities and cut down on transaction costs.”
Focus on your overall returns rather than short-term market movements. When you’re deriving the income you need from an investment, it doesn’t matter as much if the value of the underlying asset fluctuates, regardless of whether it’s a stock or a bond. “If you’re still receiving regular income and there is no fundamental change in the borrower’s creditworthiness, there’s less reason to panic if the market value of your investment goes down somewhat,” says Diczok, “especially if it’s a bond you plan to hold till maturity.”
Regardless of your approach, he adds, “make sure that your portfolio includes a range of income sources that are appropriate for your goals, timelines and risk tolerance.”