If you depend on fixed-income investments for at least part of your income, you probably haven't been too happy in recent years, as interest rates have hit historic lows. Nonetheless, even in a low-rate environment, you can broaden the income-producing potential of your investment portfolio.
However, before taking action, it's helpful to know what the near-term direction of interest rates may look like. The Federal Reserve has stated that it plans to keep short-term rates at their current historic lows until at least mid-2015. The Fed doesn't control long-term rates, making them somewhat less predictable, but it's still likely that these rates will rise sooner than short-term ones.
In any case, rather than worry about something you can't control – that is, interest rate movements – try to focus on those things you can accomplish. And one achievable goal is to create an investment mix that includes three types of income: variable, reliable and rising.
•Variable income investments – Some variable income investments, such as certificates of deposit (CDs), offer significant protection of principal, and the value of your investment won't change with fluctuating interest rates, provided you hold your CD until maturity. Of course, current rates are quite low, which means CDs provide you with little income today, but their rates have the potential to rise along with short-term interest rates.
•Reliable income investments – When you purchase reliable income investments, which can include individual bonds, you have the opportunity to earn more income today, and more consistent income over time, than you'd typically get from variable income investments. However, you will likely also experience greater price fluctuations as interest rates change. Specifically, as interest rates rise, the price of your existing bonds typically will fall.
•Rising income investments – When investing for income, you'll want to keep at least one eye on inflation – because if the interest rates paid on your CDs and individual bonds are lower than the annual inflation rate, you may lose purchasing power. If this gap persists over time, it could grow into a real problem for you. Consequently, you'll want at least some of your investment income to come from rising income investments, such as dividend-paying stocks. Of course, not all stocks pay dividends, but with the help of your financial advisor, you can find companies that have paid – and even increased – their dividends for many years running. And if you don't actually need the dividends to supplement your cash flow, you can reinvest them to build your ownership stake in these stocks. Keep in mind, though, that companies can reduce or discontinue dividends at any time. Also, remember that stock prices will constantly rise and fall, so the value of your principal could decline.
As you can see, all three types of income-producing investments – variable, reliable and rising – offer some benefits, along with some risks of which you need to be aware. But putting together a mix of these investments that's appropriate for your individual needs, goals and risk tolerance may help you boost the productivity of the "income" portion of your portfolio – no matter what's happening with interest rates.