Diversifying and Laddering Are Two Ways to Protect Your Retirement Income
by Shane Flait, ©2011

 Assuring yourself a steady yearly income is important during your retirement. Your pension and social security income do just that. But if you also want to smooth out the income fluctuations that your investments produce, you can do so using two strategies – diversifying and laddering your investments. This article shows how you’d do just that.

If choose your investments to supply you with income to live on, you may choose from stocks that regularly pay good dividends or count on cashing in on stocks that grow through capital appreciation. You can also choose from interest paying investments like bonds, CDs or annuities.   

But all investments fluctuate as their markets. Equity-based stocks vary with the economy, and interest rates vary too. Two ways to smooth your return from such fluctuations are by diversifying them and by laddering them. Here’s an example of each.

Diversify cyclic stocks

Some stocks – like airline stocks – are cyclic. They’re value is strongly influenced by economic conditions. When the economy picks up, travel picks up, so airline stocks rise. But they tend to go down when the economy tightens. At the same time, another industry’s stocks follow a cyclic behavior that may follow a contrary behavior. Take advantage of investing in both types to smooth out your income.

So, as you choose stocks for your portfolio, don’t choose stocks with the same cycle. Mix stocks with different cycles to even out your portfolio’s performance.

Maintain diversity among different industry stocks. Don’t inadvertently load up on only pharmaceutical-related stocks. If they go out of favor you want enough unrelated stocks investments that can partially ameliorate the loss.

Of course, you’d make more money if you invested all in the rising stocks and sell them before they head south. But that’s difficult to do. Trying to do so can lead you into big losses – and that’s what we’re trying to prevent. Diversification may cut your potential profits and maximum possible income, but it protects you from big losses that are hard to recover from. Remember, you need the income and don’t want to have to sell for income when your stocks are all low.

Laddering income investments makes for a steadier income

Market changes can bring down interest rates and force you to buy into lower paying assets for quite some time. Laddering can help you smooth out the impact of market changes on your income. It’s especially good for bond type investments.

When you ladder, you choose investments with different maturity dates, and split your total investment more or less equally among different bonds maturities. As each bond matures, or comes due, you receive the full principal to reinvest in a new one. If interest rates have dropped, say from 7.5% to 5.5% on medium-term bonds, only that part of your total bond investment has to be reinvested at the lower rate. By the time the next bond matures, rates could be up again.

If they are historically high, invest in a long maturity bond. If rates are lower, invest in a shorter maturity.  But remember that the longest maturities always tend to give you the highest interest rates of all prevailing rates. And laddering is geared to eventually put you into long term bonds that each gave you the highest rates when they were bought. That’s the benefit of having laddered bonds. So, laddering is a way to keep your investments somewhat liquid, yet at the same time protect yourself against having to invest all your money at once if rates are low. That’s what laddering protects you from.

Laddered investments can also be used as a regular source of income. As they come due, you can put the money into more liquid accounts to use for living expenses. By planning those cash infusions, you can avoid having to sell off other investments that would continue to produce income – like stocks, longer term bonds, or mutual funds.

Diversifying your investments can offset or reduce expected market fluctuations over time. Laddering helps you maintain your income. These strategies help you from losing sleep over every market fluctuation that will surely occur over the long run.

 Shane Flait is a writer and educator. Get more info at www.EasyRetirementKnowHow.com