A client I’ve worked with for some 18 months recently asked me if COVID-19 would derail her retirement. She had wrapped up her career earlier this year and, understandably, had many concerns after riding a roller coaster through the COVID economy.
This has been a difficult year for investors with markets cratering, rallying, tumbling and then, rallying again. While stocks, in general, are well above their March low, it’s still a hard time to be an investor – especially if you’re retired. It’s hard for us to see where we stand overall.
But there is an investment strategy that I’m partial to for weathering difficult times, including this particularly nasty patch – income investing.
If you’ve not heard about income investing, you might want to take notes. This approach to investing is my core investment philosophy. When done right, the strategy can be powerful and can yield income, even in the face of market adversity.
Income investing all boils down to creating a portfolio of assets that generate income, such as stock dividends, that is reinvested to help turbocharge the growth of your savings.
Overall, portfolio income has generally remained stable, despite the COVID crisis. In fact, the data shows that a whopping 88% of dividend-paying companies in the S&P 500 have kept or grown their dividends in the last twelve months, according to Ned Davis Research, Inc.
Income investing is different from growth investing. The growth strategy focuses on buying shares of companies that devote their resources to expansion in their respective industries and the market. The game plan with growth investing is to identify companies with the potential to become dominant and hold onto those shares in hopes that the business soars higher and higher over the years or decades. Growth investors make their money by eventually selling their stake at a profit.
Income investing approaches the market from a different angle.
Stock dividends. Bond interest. Cold, hard cash. This is what we’re looking for in income investing. During working years, the income would be used to reinvest. In this way, income investing can allow for more diversification and is designed to produce a steady income over the years, and still allow access to the growth sector. Once you retire, the income stream that your portfolio generates can be redirected to your bank account to help finance the things you want to do and see in your post-career years.
Some investors are intimidated by what they see as the complexities of income investing. So, I developed a system to help investors better understand income investing. I call it the “Bucket System” because all the money you invest will fall into one of four asset groups or “buckets” that work together to help you move towards your financial goals. Let’s delve into this system.
Growth Bucket – As an income investor, you’ll want the majority of the stocks in your growth bucket to also to pay a dividend. You will find many such companies in these four categories – healthcare, utilities, telecommunications, and consumer staples. Some established tech companies also provide both growth and income. These stocks often have yields in the 2% – 5% range. Your Growth bucket can also include a limited number of fast-growing companies that don’t currently pay dividends but could offer continued significant capital appreciation over the long haul.
Income Bucket – Bonds. Various bonds. There are all types of bonds, including Treasury, municipal, corporate, high-yield, international, and floating rate. These assets range from super safe (Treasury) to very risky (high yield), and their yields vary accordingly. So, you’ll want to maintain a mix of bonds to maximize returns and protect your principal simultaneously. Depending on your particular blend, the annual yield for this bucket should be around 1% – 6%.
Alternative Bucket – This is where you use assets that aren’t stocks or bonds. Some examples are real estate investment trusts (REITs), master limited partnerships (MLPs), preferred stocks, and closed-end funds. In your alternative bucket, you are seeking higher current income than stocks and bonds. This bucket is your portfolio yield booster, as yields from these alternative investments typically range from 3% to 8% annually. Remember, however, that the opportunity to generate more income comes with higher levels of risk.
Cash Bucket – This is your emergency fund. Try to keep six months of living expenses stashed in this bucket in the form of money market deposits, CDs or cash savings. This category is about security, not earning, thus your yield will hover around 1%.
Remember that when I refer to the annual yield for each bucket, I’m talking about the amount of cash flow that you will receive from the assets in that particular bucket. Your total return will, of course, be impacted by price fluctuations of the underlying holdings in the bucket.
While I feel that the Bucket System helps provide a guide for investors to understand and implement, a Buckets-based income portfolio requires the same level of study and attention as any other. What I’ve shared here is income investing in a nutshell, and as a wise person once noted, “Any philosophy that can be put in a nutshell belongs there.”
So, take the time to study up on income investing and the various types of assets that typically comprise an income portfolio. And once you’ve established an income portfolio, tend it as carefully as you would a money tree.
My colleagues here at Capital Investment Advisors are all well-versed believers in income investing. If you’re looking for an introduction to this powerful strategy, give us a call or fill out the form below. We’d love to share what we know.
Disclosure: This information is provided to you as a resource for informational purposes only. It is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. The information contained in this piece is not considered investment advice or recommendation or an endorsement of any particular security. Further, the mention of any specific security is solely provided as an example for informational purposes only and should not be construed as a recommendation to buy or sell. Always consult your own legal, tax or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.