Eric: Hello David. Thanks for joining us today.
David: Thank you, Eric.
Eric: For retirees seeking to have a living from their savings, what types of conservative investments can help produce a portfolio that offers a steady stream of real income?
David: To successfully establish a reliable paycheck portfolio, it's important to choose cash flow-producing assets that maximize income and minimize volatility. Here are three traditional fixed-income investments to consider when building a paycheck portfolio. Mortgage-backed type. These unique bonds offer cash flows tied directly to the mortgage rate, making them a conservative choice given that mortgage payments have an external trend. Retirees can benefit from the attractive cash flows this type offers.
There are also global credit-quality bonds. These bonds issued by companies around the world offer higher yields than traditional bonds here in Canada. It's a wise decision to focus on the credit-quality space, which can offer attractive yields while maintaining a relatively low potential for default. Then there's high-yield credit. These bonds can form a steady income stream with yields 3% to 7% higher than traditional government bonds or even GICs (Guaranteed Investment Certificates).
It's essential to use an active manager to filter out bad bonds and select the best options. Just as a chef carefully selects the best ingredients to create a delicious meal, an asset manager can carefully select the best high-yield bonds to create a reliable source of income for retirees.
Eric: Excellent. What other types of income-generating assets are equity-oriented?
David: Clearly, Canadian dividend stocks are an excellent choice for a cash flow portfolio, with low volatility and favorable taxation. There are two other asset classes that retirees should consider when constructing paycheck-type portfolios. One of these asset classes is preferred shares. These are hybrid investments offering much higher returns than traditional government bonds, but with a favorable tax advantage when distributing dividends.
This type of income is taxed at a rate around 30% lower than interest income from bonds or even GICs (Guaranteed Investment Certificates), making it an excellent way for retirees to earn attractive returns while saving taxes. Another asset class is the sale of options and the income derived from these sales. This strategy can be compared to that of an insurance provider. The investor provides protection to another investor in exchange for a premium. Option writing can provide a reliable source of income with an insurance premium potentially in excess of 7 or 8% per annum if managed correctly. It's like getting paid to protect your assets against market risks.
Eric: What risk management strategies should investors put in place to ensure that their portfolios continue to generate much-needed income?
David: When selecting cash flow-producing assets for a paycheck-type portfolio, there are three key considerations to keep in mind. Consistency: it's especially important to ensure that the frequency of cash flow distribution matches your needs. For example, if you need monthly cash flow, you want to choose investments and funds that offer monthly cash flow. Sustainability: this is probably the most decisive factor to consider. It's essential to determine whether the cash flow can be maintained organically in perpetuity, so that your paycheck is constantly coming in.
Taxation: the third factor to consider is the taxation of investments and the fields in which they are placed. For example, interest-bearing investments such as bonds are fully taxable in registered accounts. It is therefore preferable to place highly taxed assets in registered accounts whenever possible. Think about optimizing your tax efficiency. It's like keeping your car's engine in good condition to maximize its performance.
Eric: David, thank you for the valuable information you've given us today and for your time.
David: Thank you, Eric.
