LearnBonds.com recently launched the monthly subscription newsletter Income Investing Insider. As the author of that newsletter, it seems natural that I would have a passion for income investing. And I do. Over the next couple of weeks, I will write a series of articles on income investing, explaining what it is and outlining why various assets classes and asset class categories might be included in an income-focused investor’s portfolio. I will also discuss the types of things income-focused investors should concern themselves with from a macro-picture view.
Introduction to Income Investing
Over the course of an investing lifetime, many people will likely experience changing investment goals, risk tolerances, and time horizons. During the investing journey, especially in its latter stages, many investors shift their focus to income generation rather than capital appreciation. But people in their early years of investing can also benefit from income-focused investing. By collecting after tax, above-inflation income from investments providing significant principal protection and reinvesting that income in securities also providing after tax, above-inflation income, with significant principal protection, investors can grow their wealth in a methodical way over extended periods of time. Such a strategy might prove especially fruitful in an economic- and inflationary-environment that one can reasonably expect to be slow or below historical trends.
What specifically is the crux of income investing? Income investing involves focusing your efforts on creating diversified streams of income with as little risk to principal as you feel is possible in order to sustain your purchasing power over time. Income investing involves using your money to create more money in a way that is much more predictable than putting all your eggs in one or two baskets and hoping they grow over time. While it is true that strictly focusing on capital appreciation over income can reap far greater rewards, income-focused investing brings with it greater predictability and greater certainty than capital-appreciation-focused investing does. I do not believe one can ever achieve 100% certainty when investing. But a strategy that makes planning for the future more predictable will likely be an attractive option to many investors.
With that said, there is a role in the income-investor’s portfolio for some securities that both provide income and theoretically allow for unlimited capital appreciation. I will address those securities later in this series.
The Macro Picture – What Should Be the Income Investor’s Focus?
The two greatest risks to the income investor are credit risk and inflation. Making sure your portfolio is adequately diversified can help you manage these risks, and following the broader macro environment can help you monitor these risks.
In terms of credit risk, a weak economic environment will bring with it challenges for businesses that could result in greater rates of debt defaults and very weak stock prices. For a broad sense (not company-specific sense) of how the economy is trending, I like to monitor the labor market, manufacturing indices, retail sales, durable goods order, consumer credit, and housing market data. I also keep my eye out for other pieces of information that help build a well-rounded, realistic view of the economy.
Concerning inflation, an investor whose portfolio is heavily weighted toward fixed income, even if the yield is quite attractive, runs the risk of longer bouts of moderate-to-high inflation eroding the purchasing power of his or her investments. Inflation that remains contained at lower levels makes it easier for income-focused investors to generate after tax, real returns from their income streams. In terms of monitoring inflation and the potential for inflation, I like to monitor wages, income, consumer and producer prices, and again, consumer credit. Of course, as someone interested in fixed-income, I also monitor interest rates. But in my experience, the bond market has yet to tell me something I didn’t already know about inflation. Therefore, I monitor interest rates more from the perspective of looking for investment opportunities rather than for unique insights into current and potential future inflation trends. Also, the health of the labor market can provide clues as to how future wage growth may trend. Income Investing Insider will provide a monthly update on these economic indicators and some of my thoughts surrounding things of a broader macro nature.
In the next article, I will examine the role common stocks can play in the income investor’s portfolio. This will include a discussion of both individual stocks and equity funds.
More from The Financial Lexicon:
Learn how to generate more income from your portfolio.
Get our free guide to income investing here.