Creating a retirement income strategy: the different routes to consider

We all work hard during our career to put money away for later in life, with a key focus on growing wealth over time. Hitting retirement often calls for a shift to the investment strategy that might have been in places for decades.

It’s easy to say you move from growth to income, yet the way you pivot depends on your age, risk appetite, life expectancy, and other assets to help fund your golden years.

What matters is getting the balance right between growth and income as you grow older and understanding the different types of income-generating investments. They aren’t all the same, and it pays to spend a bit of time comparing the key types.

Early retirement age: putting a plan into action

Someone lucky to retire at 55 must be confident they have adequate money to pay the bills and fund their lifestyle. That doesn’t necessarily mean they are rich; instead, they might simply be good at budgeting or live frugally.

Investment growth is important for someone retiring at this age, as they might need their portfolio to last 30 years or more, particularly if they are not buying a pension annuity. Even though they are technically retired, switching to a pure income investment strategy might have its drawbacks. One is the impact of inflation which can erode the purchasing power of your money. It’s important to consider investments that can deliver a growing income stream above the rate of inflation.

It is possible early retirees will need to have a good chunk of their portfolio in growth-style investments where the bulk of the returns come from capital growth rather than dividends. Alongside these investments might be a blend of higher and lower risk income opportunities such as equity income funds and trusts, multi-asset funds and strategic bond funds.

A similar thought process might apply to someone retiring at 60 as they'll have to wait until age 67 to claim the state pension. They might need to lean heavily on their pension or savings in the interim. A 60-year-old might want to have more in bonds compared to a 55-year-old who retired early but still have some growth-style investments to power them through the later years.  

‘Normal’ retirement age: what to consider

A lot of people associate 65 with a typical retirement age. At this point, you might still want an element of growth in your portfolio, particularly if you have a long life expectancy. Sustainability of income is important as well as diversification in terms of where you generate that income.

Risk appetite might be moderate to low which suggests bonds might play a bigger role than before. That trend might gather pace as you go into your 70s – further dialling down exposure to stocks and shares (aka equities) and increasing bonds or money market funds.

These scenarios are not an investment recommendation, and individual circumstances will differ from person to person. However, it could help to stimulate ideas as part of your own investment research process. Let’s now look at various income-generating investment categories and the roles they might play.

Income-paying funds that invest in shares

There is a rich array of actively managed funds that prioritise income by investing in a basket of shares. Better known as equity income funds, these investment products typically work in one of two ways.

Open-ended funds receive dividends from the companies in their portfolio, and they pass that money onto their investors. Investment trusts do the same, but they can keep back 15% of annual revenue in reserve to help top up dividends in leaner years. This gives investment trusts an edge as they can provide smoother income streams over a longer period.

Equity income funds typically pay dividends once a quarter, although there are some funds that pay out once a month.

Not everyone wants to use actively managed funds, often because they want a lower-cost option. Fortunately, there is plenty of choice for passive equity income funds.

At the most basic level is an ETF tracking a market such as the UK that offers a dividend yield, but with the added potential of growing your capital as well. You can also invest in ETFs that target the highest yielding stocks.

The broad range of passive funds allows you to be more demanding of your investments. Two types of ETFs take a tougher stance on which companies make the cut for a place in the portfolio: those labelled ‘dividend aristocrat’ and those with ‘quality dividend’ or ‘quality income’ in the name.

If you rely on investment income to cover your bills, dividend reliability matters. You want payouts that are not only steady but grow each year, ideally faster than inflation. That’s where dividend aristocrat ETFs can help.

These funds track companies that have increased their dividends for at least 10 straight years – and some demand a 25-year track record. That level of consistency often signals strong earnings and a resilient business model.

ETFs with ‘quality dividend’ or ‘quality income’ in the title go a step further. They typically select companies with robust financials, such as solid balance sheets and low debt. The result is a portfolio focused on businesses that look well placed to deliver reliable, growing dividends – though even the strongest companies can hit bumps along the way.

You can also find ETFs labelled ‘dividend leaders’. These track indices that pick companies with a strong record of consistent dividend payments and the ability to keep those payouts coming. Some even add an ESG filter, favouring businesses that score well on environmental, social and governance measures.

Investing in bonds for income

Bonds provide a regular stream of income. Their prices typically move up and down less than equities, and they can help protect a pension during market downturns. While they don’t provide complete protection, they can help to cushion any blows. You can choose to either hold an individual bond or invest through a bond fund. Bond funds allow easier access and diversification to your assets. But, if you choose to purchase an individual bond and hold it to maturity, you won’t need to worry about any changes in price along the way, as your bond will still pay the agreed interest.  

Bonds are useful when it comes to working out how to pay the bills as they provide a fixed level of income. For example, if you buy a bond that matures in 10 years’ time, you will have a predictable stream of income with payments made every six months, and the face value of the bond returned upon maturity.

Although bonds are deemed lower-risk investments than equities, they aren’t risk-free. The worst-case scenario is the bond issuer defaulting – i.e. not paying back your money or making the interest payment – and that risk is reflected in the return on offer. Higher yields normally indicate a higher risk investment.

Types of bond funds

An active bond fund is a way to add fixed income to your portfolio and let someone else do the hard work of picking investments. A fund manager will look for the opportunities on the bond market, analyse the risk of default per bond issuer, and curate a portfolio of their best ideas.

Passive bond funds are designed to mirror the performance of a specific bond index and may have lower charges than active bond funds. Each index will have certain criteria to determine which bonds are included, and when they must leave the index.

Whether they are active or passive, bond funds typically fall into one of the following categories. The table is ranked from low to high risk.

Why interest rates matter to bonds

Interest rate expectations are important for bonds and it’s vital to understand the relationship between the two.

If interest rates go up, new bonds will be issued at higher rates. That makes existing bonds less attractive and so their price falls until their yield is in line with the new market rate. Prices and yields move in opposite direction. When interest rates fall, bond prices rise (and yields drop).

The value of a bond that has longer to run until maturity will move more dramatically when interest rate expectations change than a short-dated one.

Inflation is also part of the equation. Interest rates typically go up when inflation is high. Inflation erodes the real value of a bond’s fixed payments, making them less attractive, so prices fall.

For people still building up their retirement savings, falling prices create the opportunity to buy more bonds at a cheaper level. For those in retirement, short-dated bonds might appeal more than longer-dated ones because, in theory, they should be less sensitive to interest rate movements and be less volatile. But, if you plan to hold bonds to maturity, the price of the bond after you purchase is less of a factor.  

All-in-one funds

These are also known as multi-asset funds as they mix and match various assets under one roof. You can get a blend of shares, bonds, and some even include property and gold.

The managers choose where to allocate money in the investment market, and how to spread that money around, but they don’t pick individual bonds or shares. Instead, they invest in other funds that focus on certain areas.

AJ Bell has a range of multi-asset funds where you can choose between risk levels including two income funds. Higher-risk funds have more of their holdings in shares, and as you go down the range, the lower-risk funds have more holdings in bonds and cash.

Money market funds

Money market funds are a lower-risk investment category, and they hold short-term debt issued by companies and governments. They aim to create a slightly better return than cash in the bank.

How to look for funds

Once you’ve built a list of fund categories to explore, go to AJ Bell’s fund screening tool to narrow down the investment universe. It’s a free service where you can use drop-down menus to say what type of funds you want, and it then brings up a list of the available options.

Alternatively, AJ Bell has a list of its favourite funds, which include various equity and bond funds. This list is put together by AJ Bell’s investment team and is a shortlist of funds based on specific criteria.