Investing for income is a strategic investment approach where the primary focus is on generating ongoing cash flow rather than capital appreciation. Income investing entails building an investment portfolio that consists of assets such as bonds, dividend stocks, real estate and annuities that generate a regular income stream.
This strategy can provide financial stability and flexibility at any stage of an investor’s life but is especially useful during retirement. If you are not yet at the stage of life where you need to live on the income generated by your investments, you can reinvest the interest to compound your returns over time. This can help accelerate the growth of your wealth and generate even more income in the future.
Today we will discuss two of the types of assets that can form a part of an income portfolio- bonds and dividend stocks.
Bonds are fixed-income securities issued by governments, municipalities, or corporations. When you invest in bonds, you are essentially lending money to the issuer in exchange for regular interest payments and the return of your principal at maturity. Bonds are generally considered less risky than stocks and can offer reliable income, making them a valuable addition to an income-focused portfolio.
Bonds pay interest usually semi-annually or quarterly. A few only pay interest once a year. Bear that in mind when selecting the bonds for your income portfolio. By buying several bonds that pay during different months you can create a steady, predictable income stream.
With the help of a financial advisor, you can also take things a step further- buying bonds that mature at different times (bond laddering). This would allow you to receive principal repayments i.e. large lump sums periodically, to either cover expected/planned expenses or redeploy the funds in new bonds to replace the income. This is especially useful in a rising interest rate environment since you will have the opportunity to reinvest the proceeds in bonds with higher coupon rates, thereby increasing the size of the interest payments you receive.
When selecting stocks to add to your income portfolio, you should be aware that not all stocks pay dividends and you should also understand the difference between preferred stock and common stock. Dividend stocks are shares of companies that distribute a portion of their profits to shareholders in the form of dividends. A preferred stock pays stockholders set dividend payments on a regular schedule but does not have voting rights or as much potential for capital appreciation as common stock.
Since dividend payments on stocks are tied to a company’s profitability and cash flow, they are not guaranteed. Negative changes in the company’s financial situation can lead to reductions in the amount of the dividend payments or payments not being made at all.
When businesses have enough profit to pay dividends, they prioritize preferred shareholders first, and then pay common shareholders if there are funds left over. Additionally, there is a type of preference shares known as cumulative shares that allow for the accumulation of unpaid dividends that must be paid out at a later date. So, once a struggling business finally rebounds, those unpaid dividends are remitted to preferred shareholders before any dividends can be paid to common shareholders.
Look for companies with a history of stable dividends, solid financials, and a commitment to shareholder returns.
The exact configuration for an income portfolio will depend on the investor’s income goals, circumstances, time horizon and risk tolerance. Economic conditions, interest rates, and market trends can impact the performance of income-generating assets. Therefore, it is important to regularly monitor your income-focused investments and make adjustments as needed.
Toni-Ann Neita-Elliott, CFP is the Vice President, Sales & Marketing at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm
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