Oppenheimer & Co. Inc. Craig Chapman, CFP Director-Investments, Financial Advisor 14636 N. Scottsdale Road Suite 175 Scottsdale, AZ 85254 480-596-1512 craig.chapman@opco.com http://fa.opco.com/craig.chapman/ Generating Current Income Page 1 of 5, see disclaimer on final page
Generating Current Income Introduction There are times when you might want to set up an investment portfolio with the primary goal of generating current income to either help pay existing bills or boost the amount you're able to spend annually. For example, you may be retired (or near retirement) and need additional income to supplement the amounts you receive from Social Security and any pension plan. A younger person with adequate savings for such long-term financial goals as retirement and paying for college might still want to generate additional income to increase his or her current standard of living. Even if income is your primary goal for your portfolio, the basic factors that affect any investment decision still come into play, such as: Your time horizon: How long will you need your income stream to last? Do you want or need to have money left at that point, or do you plan to exhaust your entire portfolio in providing that income? Will the portfolio also be used for any other purpose--for example, to fund a grandchild's college tuition at some point? If you plan to use the portfolio for income only for a certain period, when will you need the remaining amount? The longer you need your portfolio to produce income, the more you need to consider the long-term impact of inflation on the income it will produce. And tapping principal as well as interest, dividends, or other forms of investment return to provide a portion of your income will have a profound impact on how long the portfolio will be able to last. Your risk tolerance: If you're relying exclusively on this portfolio as your only source of income, you may need to be more conservative with your investment choices unless the portfolio is so large that you can afford variations in your monthly or annual income. If you have other income sources or you have a greater ability to survive fluctuations in income, you might be able to consider securities that may involve more volatility but may also have potential to produce a higher return. If you are risk averse, you probably want to purchase high-quality money market instruments such as T-bills, or short- to medium-term bonds. If you are more of a risk taker, you might consider high-yield bonds and other securities that may have more volatility but the potential for greater income. Your ability to diversify: You'll need to carefully consider how much diversification you're able to achieve given the amount you have available to invest. Depending on the type of investment, you may be able to diversify your holdings by investing in individual securities, T-bills, dividend-paying stocks, and other types of dividend- (and interest-) paying securities. However, mutual funds offer a way to achieve greater diversification at a lower cost than you might be able to achieve on your own (though diversification alone cannot guarantee a profit or protect against the potential for loss). Caution: Before investing in any mutual fund, you should carefully consider its investment objectives, risks, fees, and expenses, which are outlined in the prospectus available from the fund. Obtain a copy and read it carefully before investing. Also, just because you want your portfolio to produce income doesn't necessarily mean you should have 100 percent of your money in bonds (the traditional focus of income-oriented portfolios). There are many investment possibilities that can help generate income while also providing additional diversification. Examples of assets capable of producing income Bonds As noted above, bonds are the traditional foundation for an income-oriented portfolio, because the interest payments they offer are a natural fit for an ongoing income stream. A portfolio of individual securities allows you to select specific maturity dates, interest rates, and desired level of credit risk, and using bond strategies such as laddering maturities can give you the flexibility to adjust to changing interest rates. Bond mutual funds offer the benefit of professional management, while bond index funds or exchange-traded funds can be a cost-efficient way to diversify. There are many different types of bonds and/or bond funds from which to choose in building a bond portfolio, including corporate bonds, municipal bonds, U.S. Treasury securities, agency bonds, and mortgage-related securities. Within these general categories, there are plain-vanilla bonds with fixed coupon rates and others that have special rights, restrictions, collateral, or ways of paying interest, so make sure you're aware of any special features and risks each one involves, particularly if you're considering an individual bond. For example, some bonds include a provision that permits the company to redeem the bond before it matures; if that happens, you would need to find some other investment in which to reinvest your principal and replace that income. In general, longer-term bonds offer higher interest rates than shorter-term bonds issued at the same time. It's important to remember that though a bond's coupon rate may be fixed, its market value can fluctuate (unless held to maturity). Also, bond yields move in the opposite direction from bond prices, so the income from a bond fund can vary, too. Page 2 of 5, see disclaimer on final page
Certificates of deposit (CDs) Certificates of deposit pay a fixed interest for a fixed period of time, usually at a higher interest rate than a savings account. However, typically that interest is paid when the CD matures, and a penalty is charged for cashing in the CD before its maturity date. As a result, you would likely need to invest in multiple CDs that mature at varying times in order to achieve an ongoing stream of income. Bank-issued CDs are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor per bank. A brokered CD is a bit different from a bank-issued CD. It may have a much longer term and may pay interest at designated intervals rather than at maturity. However, it may have a call feature that permits the issuer to redeem it before maturity, and if it is traded in the secondary market, the price you get may be more or less than your original investment. Finally, if a brokered CD is issued through a bank or thrift where you already have an account, the $250,000 FDIC insurance covers both your CD and that account; anything over the $250,000 limit is not insured (unless it is in a retirement account, which is covered separately). Dividend-paying stock Companies that share their profits with their stockholders by paying a dividend are another potential source of income, as are mutual funds that invest in them. However, dividends from common stock are by no means guaranteed; they depend on a company's performance, and a company's board of directors can decide to reduce or eliminate them. Dividends are taxed either as ordinary income or as qualified dividends. In order to be taxed as a qualified dividend, you must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date, and the dividends must be paid by a domestic corporation or a qualified foreign corporation. Qualified dividends are generally taxed at the rates applicable to long-term capital gains. Dividends on common stock are paid only after the company's obligations to bondholders and holders of preferred stock are taken care of. Preferred stock offers a fixed rate of return paid out as dividends. Because dividends on preferred stock are paid before any dividends to the common stockholders, they offer greater certainty about the level of income you'll receive. (However, if the company does well and increases its common-stock dividend, preferred stockholders still receive the same payments.) Some mutual funds specialize in dividend-paying stocks; these may be known as income funds, growth-and-income funds, or equity-income funds. Balanced funds may invest in both stocks and bonds. Real estate and real estate investment trusts (REITs) A REIT buys, develops, manages, and/or sells real estate such as skyscrapers, shopping malls, apartment complexes, office buildings, or housing developments. Rather than investing directly in real estate, REIT investors invest in a professionally managed portfolio of real estate. Some REITs trade on the major exchanges, just like stocks, while others, known as non-traded REITs, are not. REITS may make money from rental income, profits from the sale of property, and other services to tenants. They do not pay taxes as long as they pay out at least 90 percent of their net income to their investors. If you prefer a more hands-on approach, you can invest directly in real estate that offers rental income. However, you should be certain that you're prepared for the headaches involved in being a landlord. Distribution funds In addition to mutual funds that specialize in income-paying stocks or bonds, a relatively new type of mutual fund attempts to provide income over a given period of time. Generically referred to as distribution funds, retirement income funds, or managed payout funds, they are managed to try to provide either a given level of income, or provide income over a specified time period. Many allow you to withdraw money as needed. (However, there is no guarantee that they will always be able to achieve the intended return or last as long as indicated, and withdrawing money from it may reduce the longevity of your investment in a fund.) Annuities Annuities represent a contract between an individual and the issuer (usually an insurance company). An annuity can guarantee a stream of income, though any guarantee is subject to the claims-paying ability of the company issuing the annuity. In order to receive an income stream from an annuity, you would either withdraw money periodically from the amount available in the annuity contract, or annuitize the contract. With annuitization, the issuer promises to pay you an amount of money periodically (monthly, quarterly, yearly, etc.), though any guarantee of payment is subject to the claims-paying ability of the issuer. You can elect to receive either a fixed amount for each payment period (called a fixed annuity payout) or a variable amount for each period (a variable annuity payout). With a variable annuity, the issuer does not guarantee or project any rate of return on the underlying investment portfolio. With an annuity, you can receive the income stream for a specific time period (for example, 10 years), over your lifetime, or over your lifetime and the lifetime of another person (called a "joint and survivor annuity"). You may purchase an annuity with a single lump sum and begin payments within one year (an immediate annuity) or allow your initial investment to accrue any earnings tax-deferred over time (a deferred annuity). Variable annuities are long-term investments suitable for retirement funding and are subject to market fluctuations and investment Page 3 of 5, see disclaimer on final page
risk, including the possibility of loss of principal. Variable annuities contain fees and charges including, but not limited to, mortality and expense risk charges, sales and surrender (early withdrawal) charges, administrative fees and charges for optional benefits and riders. Be sure you understand the provisions of a given annuity before buying. Caution: Most immediate annuities do not allow for partial withdrawals (though there are some exceptions). Also, any withdrawals from a deferred annuity made prior to age 59½ may be subject to a 10 percent federal income tax penalty. Caution: As with a mutual fund, variable annuities are sold by prospectus. You should consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus contains this and other information and can be obtained from the insurance company issuing the annuity or from your financial professional. Read the prospectus carefully before investing. Taxable or tax-free investments? One consideration in setting up an investment portfolio to generate current income is whether your net income would be enhanced by purchasing tax-free securities (such as municipal bonds) or taxable investments (corporate bonds or dividend-paying stocks). Taxes naturally reduce earned income, but it does not necessarily follow that tax-free securities will provide more income. How much income you will net depends on the investment's yield and your personal tax bracket. To determine which type is best for you, you will need to compare after-tax yields. Compare taxable and tax-exempt investment returns as follows: Convert your tax bracket into a decimal and subtract it from one (e.g., the 35 percent tax bracket becomes 0.65). (In the case of dividends that are taxed at the capital gains rate, substitute the appropriate tax rate instead of your ordinary income tax bracket.) Divide the yield of the tax-exempt investment by the result (e.g., if the tax-exempt yield is 5 percent, then divide 5 by 0.65 to obtain 7.6923 percent). If you were in a 35 percent bracket, you would need a taxable investment that yields greater than 7.6923 percent to beat the yield of a tax-exempt investment that yields 5 percent. Page 4 of 5, see disclaimer on final page
The content herein should not be construed as an offer to sell or the solicitation of an offer to buy any security. The information enclosed herewith has been obtained from outside sources and is not the product of Oppenheimer & Co. Inc. ("Oppenheimer") or its affiliates. Oppenheimer has not verified the information and does not guarantee its accuracy or completeness. Additional information is available upon request. Oppenheimer, nor any of its employees or affiliates, does not provide legal or tax advice. However, your Oppenheimer Financial Advisor will work with clients, their attorneys and their tax professionals to help ensure all of their needs are met and properly executed. Oppenheimer & Co. Inc. Transacts Business on all Principal Exchanges and is a member of SIPC. Oppenheimer & Co. Inc. Craig Chapman, CFP Director-Investments, Financial Advisor 14636 N. Scottsdale Road Suite 175 Scottsdale, AZ 85254 480-596-1512 craig.chapman@opco.com http://fa.opco.com/craig.chapman/ Page 5 of 5 Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2017