Investing for Income - Long Term Conservative Investment Strategy

The aim of investing for income is putting together a collection of stocks, bonds and other asset classes that generates the highest possible annual income at the lowest possible risk.

Investing for income or income stock investing approach aims to pick companies that provide a steady stream of income and is one of the most straightforward stock-picking strategies. When investors think of steady income they commonly think of fixed income securities such as bonds. However, stocks can also provide a steady income by paying a solid dividend. Over time, dividend payers have historically outperformed other investments, with quite a bit less volatility; a win-win for investors.

Like value stock investing, investing for income is a buy-and-hold strategy and income investor is not concerned with short-term market trends. However, that's where the similarity ends, income investors aren't looking for undervalued companies, they are looking for safe incoming producing assets, there is much less emphasis on capital growth.

Income investors usually end up focusing on more established firms, large caps, blue chips, which have reached a certain size and are no longer able to sustain higher levels of growth. These companies generally no longer are in rapidly expanding industries and so instead of reinvesting retained earnings into themselves as many high-flying growth companies do, mature firms tend to pay out retained earnings as dividends as a way to provide a return to their shareholders.

Investing for Income and Dividend Yield

Investing For Income

Income investing is not simply about investing in companies with the highest dividends in dollar figures. The more important gauge is the dividend yield, calculated by dividing the annual dividend per share by share price. This measures the actual return that a dividend gives the owner of the stock. For example, a company with a share price of $100 and a dividend of $3 per share has a 3% dividend yield, or 3% return from dividends. The average dividend yield for companies in the S&P 500 is 2-3%.

Another factor to consider with the dividend yield is a company's past dividend policy. Income investors must determine whether a prospective company can continue with its dividends. If a company has recently increased its dividend, be sure to analyze that decision. A large increase over a short period may turn out to be over-optimistic and unsustainable into the future. The longer the company has been paying a good dividend, the more likely it will continue to do so in the future. Companies that have had steady dividends over the past five, 10, 15, or even more years are likely to continue the trend.

Investing for Income - Dividends are Not Everything!

You should never invest solely on the basis of dividends. Keep in mind that high dividends don't automatically indicate a good company. Because they are paid out of a company's net income, higher dividends will result in lower retained earnings. Problems arise when the income that would have been better re-invested into the company goes to high dividends instead. The driving principle behind investing for income strategy is to find good companies with sustainable high dividend yields to receive a steady and predictable stream of money over the long term.

The income investing strategy is therefore more than using a stock screener to find the companies with the highest dividend yield. Because these yields are only worth something if they are sustainable, income investors must be sure to analyze their companies carefully, buying only ones that have good fundamentals. Investing for income strategy has no set formula for finding a good company. To determine the sustainability of dividends by means of fundamental analysis, each individual investor must use own interpretive skills and personal judgment.

Income Investor Guides for Picking Stocks

Income investor would want dividend stocks that had several characteristics such as:

  • A dividend payout ratio of 50% or less with the rest going back into the company's business for future growth. If a business pays out too much of its profit, it can hurt the firm's competitive position.
  • A dividend yield of between 3% and 6%. That means if a company has a $30 stock price it pays annual cash dividends of between $0.90 and $1.80 per share.
  • The company should have generated positive earnings with no losses every year for the past three years, at minimum. Income investing is about protecting your money, not picking risky stocks.
  • A proven track record of increasing dividends. If management is shareholder friendly, it will be more interested in returning excess cash to stockholders than expanding the empire, especially in mature businesses that don't have a lot of room to grow.
  • A high return on equity (ROE) with little debt. If a company can earn high returns on equity with little debt, it usually has a better-than-average business. This can provide a bigger cushion in a recession and help keep the dividend checks flowing.

Investing for Income is a Conservative Investment Strategy

Income investing is a very conservative investment strategy. Income investors don't have to worry about their portfolios dropping 3% in a single day which does occasionally happen to the stock market. Even if they take short-term losses due to market volatility, they know that the type of stock in their portfolio will eventually recover.

What You Should Be Careful About When Investing for Income?

Remember that saving money and investing money are two different things. Even if you have a broadly diversified income investing portfolio that generates lots of cash each month, it is vital that you have enough savings on hand in risk-free FDIC insured bank accounts in case of an emergency.

Income Investors want to preserve their capital and generate income, they are not trying to keep up with the market because they don't want to take on the market's risk.

One final important note: in most countries and states/provinces, dividend payments are taxed at the same rate as your wages. As such, these payments tend to be taxed higher than capital gains, which is a factor that reduces your overall return.

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