Too often, in a high-flying economy driven by powerful asset bubbles, the siren song of big risks for big returns is too powerful to ignore. Many retirement-age individuals who invested for "go-go" growth have paid a painful price. Their portfolios have diminished to such a large degree that their retirement dates must be pushed back.

Many now face the difficult decision to cut spending or dip heavily into portfolio principal to cover expenses. While the impulse for these retirement-age individuals may be to stay fully invested in all growth areas to try to make their money back, they are missing the important lesson of appropriate asset allocation and the ways an income-oriented portfolio can protect and grow their hard-earned savings.

But retirement-age clients need not resign themselves to a portfolio of Treasury bonds with pitifully low yields. Investing for income can offer opportunities for principal appreciation too, and a diversified portfolio of income investments can deliver a current income stream in today's marketplace of anywhere between 5% and 7%. Though perhaps without the same long-term upside potential of growth investments, income investments typically provide a lot less interim volatility.

In other words, it may be OK to sleep at night again after the market crash of 2008.

Beyond Laddered Bonds
Smart income portfolio investing encompasses more than just building a static ladder of bonds. Active management principles should be applied to an income-oriented portfolio as they would be to a growth portfolio. For fixed-income investments, active managers must manage the yield curve, watch sector rotation and monitor dislocations within the often inefficient credit markets for opportunities.

This last point has never been more important given the turmoil within the credit markets in 2008. As investor fears ran high last year, just about all fixed-income sectors with the exception of Treasury bonds came under pressure, often without cause. As cooler heads prevailed with the turn of the New Year, bonds have staged a significant rally so far this year and credit spreads have begun to tighten.

However, risk premiums are still generous by historical standards for many high-quality bond investments. For example, corporate bonds in the bank and finance sector still have high yields, while industrial credit spreads have narrowed significantly and may be too rich for their credit fundamentals. Callable and step-up coupon agencies are also compelling options, offering comparatively better yields than more traditional bullet agency structures. Certain sectors of the mortgage-backed and asset-backed securities markets are showing signs of improvement, too, especially as the liquidity benefits of the Federal Reserve Term Asset Lending Facility (TALF) and the Treasury Department's Public-Private Investment Program (PPIP) take effect.

Municipal bonds offer pockets of value as well, especially in revenue-backed sectors that investors have shunned, in some cases for the perceived safety of general obligation bonds. Some of the latter bonds, meanwhile, also offer a significant yield premium. But investors in those general obligation bonds must be willing to take certain risks-for example, wagering that the state of California is not going to default on its debt, despite its well-publicized budget deficits. It is important to keep in mind, meanwhile, that many high-quality corporate bonds are yielding more than municipal bonds on an after-tax basis, presenting an arbitrage opportunity-at least in the short-term-for the active fixed-income investor.

Even after a robust start in 2009, in which most high-yield bond funds were up by more than 25% as of September 1, the junk bond market still offers value with yields above 10%. While defaults in this space will clearly be higher in the future than they have averaged recently, yields this high are enough to compensate investors to take the risk. Many high-yield bond managers anticipate another 300 to 400 basis points of spread tightening before the year is done, meaning there is still room for a significant total return from both principal and income.

Earning With Equities
Beyond bonds, an income-oriented portfolio may include allocations to high-dividend paying equities, real-estate investment trusts (REITs), preferred stocks and master limited partnerships (MLPs). These instruments offer the upside potential of equity markets but with the juice of an income stream to enhance returns, income that in some cases limits the downside risk during a market correction. However, these equity investments are not without risk themselves and can experience painful downdrafts, so it's necessary to make sure the allocations within the income portfolio are appropriate for the investor's time horizon, liquidity needs and risk profile.

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