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5 reasons to become an income investor
Citywire's yield-hunting columnist provides some valuable starting information for would-be income investors.
Investing in the stock market is difficult - let no one tell you otherwise. The odds are that you did OK last year but if you are thinking of starting the New Year with a new approach why not consider becoming an Income Investor? This means that you will be seeking cash returns on your investments (whilst safeguarding your capital value) rather than trying to spot the next ‘10-bagger’ giving capital growth.In the Income Investing approach described here I am assuming a mix (in equal proportions) of income in the form of share dividends and ‘coupons’ or other payments on corporate bonds and other fixed-income securities.
I have (obviously) found this approach to work well for me - but could it be for you? Here are my top five reasons to convince you:
1. It provides income (reasonably) stable and predictable income
Bear with me. Sooner or later you are going to want to retire from the rat-race and enjoy life a bit more. You’ll need income to cover your living expenses. An income-oriented portfolio should provide a reasonably stable supplement to any other sources of income you might have (such as a pension).
What is more, income from an ISA is not counted towards many benefits, such as Child Tax Credits - in case you are unexpectedly made redundant.
Of course, if you need cash another option is to sell some of your portfolio holdings. However, the prices of these securities (particularly shares) can fluctuate wildly (think 2007/8). In contrast, the income from an income-oriented portfolio is usually much more stable, making financial planning more straightforward.
2. It’s a (fairly) simple ‘Buy and Hold’ approach
Generally, there is not a lot of admin involved - this is usually a ‘fire and forget’ investment style, although it is not completely ‘hands off’. To offer a painful example: whilst my portfolio nearly halved in value (!) during the 2007/8 crash, by continuing to hold (and not being shaken out of the market), I was able to recover most of the value of my portfolio since then. By contrast, the income was relatively stable and has continued to grow (albeit slowly).
There are, of course, times to sell – usually to take a nice profit.
What is more, the income from the portfolio – typically 5-6% – provides the opportunity to reinvest and rebalance (in my approach between dividend shares and fixed-income), without having to sell anything!
3) Comparing yields is (relatively) easy
Finding winning ‘value’ or ‘growth’ shares is very difficult in practice because there is no reliable indicator that predicts success. It is much easier to compare yields between individual shares as well as between shares and fixed-income securities. Yields represent the total market view of the risk/return equation. Yields are usually high for a reason (i.e. one or more risk factors). So do your homework, find out what the market is scared of and follow your judgement.
Usually it will be better to avoid the highest yields available in any asset class. There is, in any case, a spectrum to suit your appetite for risk:
- Around 4% for ‘risk-free’ UK gilts (excluding inflation risk)
- Around 5% for several FTSE 100 dividend shares or income-oriented ETFs
- Around 6-7% for many fixed-income securities
- Around 8-9% for some of the riskier fixed-income securities (e.g. PIBS)
4) You can combine different assets classes for less volatility
I use two main asset classes (‘half and half’): dividend shares and fixed-income securities. And there are many flavours of the latter, such as corporate bonds, preference shares, gilts, PIBS, enhanced capital notes, etc.
These two types of assets tend to complement each other: when the market is fearful, fixed-income yields are high; when the market is happier and businesses are going great guns, dividends are high.
The Citywire guide to investment trusts
In association with Aberdeen Asset Management
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