Page 40 - DIY Investor Magazine Issue 24

INVESTING BASICS: INCOME INVESTING 101
Do you need your portfolio to generate cash? Is paying your bills and having enough income to live on more important than growing richer? If so, you need to focus on income investing - writes Christian Leeming
Income investing had been out of fashion with investors during the twenty year bull market as some found it almost impossible not to pick winners; however, the current COVID-19 crisis makes the future suddenly look far less predictable, with many bracing for a global recession.
Here we take a closer look at income investing; which assets might be appropriate and the most common dangers they might face.
WHAT IS INCOME INVESTING
Income investing is the accumulation of assets - shares, bonds, mutual funds, and property - that generate the highest possible annual income with the lowest risk.
Unlike strategies for long term wealth accumulation and capital growth, most of this income is paid out to the investor to fund their everyday living costs; DIY investors are fuelling a surge of interest in income investing and the pursuit of passive income.
The ‘4% rule’ is a rule of thumb for income investors in retirement; to avoid running out of money you should not take more than 4% of the value of your portfolio out each year; it is based on academic research showing that if the market crashes, 5% can run you out of money in 20 years, whereas 3% virtually never did.
TYPES OF INVESTMENTS FOR AN INCOME PORTFOLIO
Income investors will typically create three major ‘buckets’ of assets:
Dividend paying shares: Shares in companies that reliably return profits to shareholders with safe dividend payout ratios, meaning they only distribute 40% to 50% of annual profit, reinvesting the rest into the business. Those not comfortable buying individual shares may prefer to access this income via a dividend paying
mutual fund or investment trust. What to look for in dividend stocks:
• Companies with positive earnings and no losses for the past three years, and aim for a dividend yield
of between 2% and 6% – a company valued at £30 paying 60p/£1.80 per share.
• A track record of increasing dividends – shareholder- friendly management, particularly in mature businesses with little growth potential.
• A company that achieves high return on equity (ROE) with little or no corporate debt is a better- than-average business likely to keep paying in a recession.
• Income investing is about protecting your money not punting on risky stock.
• When contemplating funds or investment trusts, look at their historical performance to identify reliable payers
Bonds: There are many types of bonds - corporate, government and savings bonds all deliver ‘fixed income’ – an agreed return on the money you lend them for the duration of the loan.
WHAT TO LOOK FOR, OR AVOID IN BONDS:
Bonds are often the cornerstone of an income portfolio as they fluctuate less than stocks; potential profit is more limited than equities but in the event of bankruptcy, you have a better chance of recouping your investment.
However bonds are not without risk and can deliver a unique set of risks for the unwary income investor:
DIY Investor Magazine | Apr 2020 40