A financial planning rule of thumb for income portfolios is to create one that allows you to live on 4 percent of your investments annually, ensuring you don’t deplete your assets before you die. To create an income-based stock portfolio, you’ll need to consider the amount of income you want to generate annually, the level of risk you are willing to take, your liquidity requirements and your tax situation.
1. Determine what annual income you desire from your stock portfolio. Calculate what annual income you will receive from bonds, CDs, pensions, Social Security, royalties and any other non-stock income you will have. Calculate your income needs for multiple years if you are planning for pre-retirement through retirement.
2. Determine what part of your desired income will come from non-stock sources and how much annual income you will need to derive from stocks.
3. Determine the level of risk you want in your stock portfolio. Divide your portfolio into three parts: aggressive, moderate and conservative, and decide what percentage of your portfolio you want for each. For example, a younger person with wage or salary income may want a larger percentage of her portfolio in aggressive stocks, while someone in retirement may want to hold more moderate and conservative stocks.
4. Meet with a tax adviser or financial planner to determine your tax situation and how growth stocks and those that yield dividends will affect your tax situation. Some dividends are considered qualified and are taxed at a lower rate. Depending on your age and if you are retired or not, you may have different tax burdens.
5. Choose income-yielding stocks, which provide dividends, rather than growth stocks, which may be more likely to lose value and be subject to greater capital gains taxes. Look at stocks that have a long-term record of providing dividends, including stocks such as utilities and blue chips.
6. Spread your stock buys among different market sectors, rather than simply buying those stocks with the best dividend record. This will prevent you from placing most of your assets into one market sector, such as technology, finance, manufacturing or utilities, which could suffer a sector-wide downturn.
7. Look for companies that pay out 50 percent or less of their profits in dividends, putting the rest back into the company, and which pay a 3 percent to 6 percent annual dividend. Look for companies with low debt and positive earnings for at least three years.
8. Look at buying exchange-traded funds. ETFs are funds that track the stocks that make up an index, such as the Dow Jones, NASDAQ or S&P 500. The goal of an ETF is to match the performance of the index. If you believe the Dow will rise in value during the course of a year, buying an ETF may be a better strategy than buying individual stocks, especially if you are a small investor.
- Consider adding bonds to your portfolio. To receive regular income from bond investments, purchase bonds with maturity dates that come one after the other, or “ladder” them each year. This allows you to receive an annual income from these bonds.
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