An Approach To Interest-Only Investing For Your Living Expenses

During retirement some people want to restrict their income only to interest income from their income-based investments. They like the security of principal that such investments have. So how might they arrange their portfolio to make this feasible over a long retirement horizon?

What such interest-based investors want to avoid is 'dipping into principal'. But preserving principal is done in two ways.

First way to preserve principle:

Here, preserving principal means not withdrawing it - just taking its interest earnings. Several investments offer interest-only payments. Examples are:

* Certificates of Deposit (CDs)

* Deferred fixed annuities, and

* High quality bonds (ideally near maturity)

These are all very secure investments. All interest taken is taxed as income.

You can get CDs with terms from a few months up to 5 years. As an example, you can buy a 6 month CD, wait the term, and then take its earnings and reinvest the principal again.

You can find deferred fixed annuities that allow you to withdraw up to 10% without incurring a surrender penalty (if you're over 591/2). Just take only the interest earned - which will be under 10%.

Near term bonds pay coupon interest for your use, and at maturity pay their face value which you can reinvest again.

Ideally you should compile a mixture of these investments for your 'interest-only' portfolio. With enough principal, you can consider laddering each of these investments to help preserve higher interest payments over long term investing.

The second way of preserving principal:

Preserving principal also means preserving the purchasing power of that principal. Inflation erodes the purchasing of a dollar and therefore will erode the purchasing power of your dollar-denominated investment principal. Inflation requires your principal, from which you're earning interest, to increase in terms of the number of dollars that make it up. And if your principal increases - and interest rates remain the same - the amount of interest earnings you withdraw will maintain its previous purchasing power too.

So, for emphasis, under comparable interest rates in the future, you'll need more principal to produce larger 'interest' withdrawals to cover the same living expenses to offset inflation's effect. It's those living expenses that will increase with inflation.

They only way to make your principal grow is by creating an 'equity-growing' portfolio. Such a portfolio is invested to grow as fast, or faster, than inflation. Hopefully, you'll be able to grow it sufficiently to offset inflation's deterioration of the principal of your 'interest-only' portfolio. Then every few years you can transfer some of your equity-growing' portfolio to increase your interest-only principal to offset inflation's damage to its purchasing power.

A mixed approach to growing your principal:

Of course, you could simply not withdraw all your interest from your interest-only investments and leave some to increase the principal over time. But then you're reducing your income for living expenses now in hope that in the future you can take the same fraction of interest earnings from a bigger principal amount. That's an approach to offsetting inflations purchasing power's deterioration on your interest income.

But this approach makes you seek higher interest rates to offset your fractional take on your earnings - and that may undermine the risk level of your interest earning principal. Breaking your money into two portfolios each with its complementary objectives - one for absolute security, the other for investment growth - keeps the risk allocated and recognized where it exists.

at 11:47 PM
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