Regardless of your overall investment outlook, your preferred investment types, or even the size of your retirement portfolio, there’s a good chance that won’t at least part of your nest egg to be in assets that generate a regular income stream.
This is often a common scenario when someone enters retirement, and needs to begin living off of what they’ve accumulated in their various retirement accounts. Rather than having to sell off investments and reduce the size of their overall portfolio, many individuals choose investments that generate an income stream and can cover some or even all of that individuals or retirement expenses.
Differences in Risk
Bonds are generally considered to be a safer investment than stocks in terms of risk to capital. Bondholders receive their interest payments before the company can pay any stockholder dividends, and bondholders are generally near the front of the line in getting any type of payout if the company experiences any significant financial difficulty.
This generally results in greater market volatility and price fluctuations of stock investments over bond investments. Investors who are looking to make trades with a relatively short or medium term time frame will need to take these risk differences into account.
Differences in Potential Upside
In the most general of terms, stocks are considered to have a greater upside potential as compared to bonds. Bondholders are limited to receiving their stated interest payments, and those payment levels won’t grow over time, in contrast to the dividend payments at a common stockholder might receive. Furthermore, bondholders won’t share in the growth of the company in the same way that stock investors will.
But that certainly isn’t to suggest that it’s impossible to realize significant capital gains through bond investing. Remember that as current interest rates go up and down, the price of any given bond to instrument will tend to vary inversely to that interest rate change. This means that as current rates fall, the value of a bond will tend to increase.
Cash Distinguished
It’s important to note that when we’re analyzing and evaluating the relative pros and cons of bonds and dividend paying stocks, we’re still very much keyed into the investment elements of those asset classes. In other words, even where the primary investment goal is current income, we still evaluate and ultimately select our investments giving consideration to whether we can also realize gains on those investments too.
Bonds and dividend paying stocks should therefore be distinguished from cash or investments such as bank CDs. In general, the purpose of those investments is not to generate current income (particularly with the historically low interest rates we’ve seen over the past number of years), but liquidity and security of principal.