Income asset allocation involves an individual creating an investment portfolio that is mainly composed of income generating assets. Many retirees receive small monthly pensions or no pensions at all, instead relying heavily on the income that their investment holdings generate. An investor can create an income asset allocation portfolio by purchasing a number of individual securities but mutual fund companies and other investment firms also sell pre-packaged funds that are almost wholly comprised of such assets.
Debt instruments such as bonds are among the securities that are generally held within an income asset allocation portfolio. Bondholders are the creditors of the bond issuers; those issuing bonds usually make monthly, quarterly, semi-annual or annual interest payments. A bondholder who owns a number of individual bonds can try to buy bonds issued on a variety of different dates to ensure that some income payments are received every month. Mutual fund companies that invest in bonds usually disperse the total annual interest payments to fund shareholders in the form of roughly equal monthly dividend payments.
The credit histories of entities that issue bonds are examined by bond rating agencies. An entity with a good history of repaying debt and high revenue levels can usually borrow money more cheaply than a bond issuer with a history of defaulting on the debts. High risk bond issuers have to pay higher yields on bonds that low-risk issuers. Many types of government issued bonds are backed by taxpayer money and government bonds are normally viewed as lower risk investments that corporate bonds. Junk bonds are high risk investments that pay above average yields and only very aggressive income asset allocation models contain these bonds.
Aside from bonds, asset allocation models also contain mortgage-backed securities, which are debt instruments tied to residential and commercial mortgages. Investment funds buy thousands of mortgages and interest payments made by the borrowers are paid into the fund. Bonds are then sold to investors and these bonds are backed by the fund itself meaning that bondholders have a partial ownership in the debts that are contained within the fund. Since mortgage borrowers make monthly payments, these securities are popular with investors who want to receive regular income payments.
Investors with moderate income needs can invest in conservative income asset allocation portfolios that mostly contain low yield government bonds. People with greater income needs often have to invest in riskier funds that contain high risk bonds. Bonds can lose all value if the entity that issues the bond goes bankrupt so people who seek the greatest levels of return also have to contend with the greatest level of principal risk.
