An issue that plagues many retirees is how to manage income in the face of the increasing cost of living. Even with moderate inflation, costs of living tend to increase over time. This can reduce the income retirees can obtain from fixed income investments, even while they must meet higher expenses. Where can you find a source of income that can keep of with inflation, along with your expenses?
One suggestion: consider putting some of your money into a portfolio of large capitalization dividend-paying stocks as an income generation alternative. This could help to provide you with an income that keeps pace with the rising costs of living. For the 30 years ending 12/31/04, the stream of dividends from an investment in a basket of stocks representing the S&P 500 index generated a growing stream of income. During that same period, interest rate from CDs fell 7.42% to 1.85% (the S&P 500 is an unmanaged group of securities considered to be representative of the stock market in general; it is not possible to invest directly in an index).
Although publicly traded stock can help you to manage inflationary risks, the dividends that these stocks pay out are highly dependent upon the overall profitability of the issuing company. Therefore, you will want to strongly consider the dividend payment history of the company prior to investing.
A few additional things should be considered about stocks and CDs. publicly-traded stocks tend to be suited for investors that are seeking asset appreciation and are willing to take on the additional investment risk. On the other hand, CDs are suited for investors that are concerned about preserving their principal investment and are adverse to market risk. With this in mind, it should be remembered that CDs are FDIC insured while publicly-traded stocks are not. The values of publicly-traded stocks fluctuate in value and may result in either a gain or loss upon sale.
The income from these investments is also subject to differing income tax rules. Stock dividends are generally subject to federal income tax of 5 to 15%, while CD interest is taxed as ordinary federal income tax rates, which can range anywhere from 10-35%. CDs also have an early withdrawal penalty if money is taken prior to maturity. On the other hand, the stock of most largely capitalized companies can typically be purchased and sold at any time when the market is open.