Income investing is crucial in every step of one’s investment cycle. Whether you want to accumulate wealth, buy a house, send your children to school, plan for retirement, or enjoy your golden retirement days comfortably, there is always an income investment that can help achieve your goals.

Income investing is simply putting your money to work in assets that generate a steady stream of income, and the money paid out is called something different depending on what the investment is. Bonds, shares, and real estate pay in the form of coupons, dividends, and rent or yield, respectively, and are the most common forms of income investing.

When one hears the term income investing, one typically thinks retirement planning or boring investments that don’t offer much growth, and so these investments are often not considered in the early days of investing where young professionals are trying to accumulate wealth.

This is, however, a false misconception, as bonds are not the only way to generate fixed- income streams, and despite their lower yields, bonds play a vital role in achieving stability in times of market volatility and also help to plot a path in terms of providing better long-term risk-adjusted returns in the long run.

BUY YOUR AGE

The general rule of thumb when it comes to determining your appropriate bond allocation is to “buy your age in bonds”.

Of course this can be different from client to client, depending on their financial needs and goals, and also more importantly the stage in their investment cycle, among other factors.

A higher fixed-income allocation will be needed for those investors who have shifted gears from the accumulation stage, into their retirement phase, as they will be using their income to live or supplement their living among their other income investments.

It is always important to have a balanced approach when investing, and to apply proper diversification techniques so as to mitigate company-specific or issue-specific risk within each asset class.

A strategic asset allocation can be chosen based on the client’s investment parameters, and this can be easily customised based on the client’s evolving financial needs and goals as they move along the investment cycle.

Portfolio managers may also use a tactical asset allocation in order to keep up with changing market conditions, thereby adjusting or going outside of the prescribed asset allocation to take advantage of select opportunities.

Real estate investments for income are most often chosen in the later years of an investment cycle, as more often than not liquidity is an issue in the early days of accumulating wealth.

REITS

That being said, investors seeking liquidity and flexibility can still generate income from this asset class through a real estate investment trust (REIT) which trades like an equity on international markets. Through this vehicle, investors have the flexibility to choose the desired country or currency in which they would like this real estate exposure, and can be proactive in exiting if the country’s economic fundamentals deteriorate, thereby allowing for a more active portfolio management approach.

In addition, they can be selective by choosing the type of REIT, whether it be retail, residential, health care, office, or mortgage, and can have the ability to diversify among the types due to the relatively low cost per share.

REITs in the US are obligated by law to maintain a dividend payout ratio of at least 90 per cent, thereby passing most of the rental income on to the client, making them a favourite for income-seeking investors.

In terms of equities, dividend investing can apply across all spectrums of the investment cycle, and therefore, can be used in all client portfolios regardless of the investment objective.

DIVIDEND INVESTING

Dividend investing is all about owning a business that will pay you, and the best dividend stocks will have a consistent track record of increasing their dividend year after year for a period of at least 10 years. The key here, as with many investment strategies, is investing in quality companies that are fundamentally strong and are growing.

As equities are more volatile than bonds, you will have to be selective in choosing companies that you will buy more if the price of the stock falls. The reason is that the dividend yield will rise once the dividend is constant or increasing, and the price of the share falls.

Providing a fundamentally strong company, these times of declining prices will represent a buying opportunity to lock in a high-dividend yield, and a great value, to then benefit from the power of compounding and potential capital gains down the line once the stock approaches again its fair or intrinsic value.

This is the foundation of true dividend investing by combining a dividend and value investment strategy together, thereby amplifying the compounded returns from the dividends along with the high margin of safety to lock in future potential capital gains.

A great example of this was the Bank of Nova Scotia Toronto, which was down 45 per cent from a year ago as of mid-February, for their exposure to energy, as well as Canada. At a price of US$38 per share, the dividend yield was approximately 5.8 per cent, which was higher than the 4.5 per cent the BNS bond was offering at the time. Those income-seeking clients that locked in the 5.8 per cent dividend yields, bought it for the dividend, and in doing so also realised unrealised gains as of the end of April of approximately 40 per cent.

In summary, income investing is beneficial to all types of investors, regardless of the stage in their investment cycle, and plays an important role in all investment portfolios by providing fixed-income streams and smoothed out long-term returns.

No asset class should be avoided in its entirety, as even select dividend-paying equities at times can be included in strict income portfolios, providing the risk/return ratio is attractive and the dividend yield is compelling for a fundamentally strong company.

Real Estate exposure can also be achieved through equity REITs regardless of the size of your portfolio, and can give you the opportunity to acquire ownership in real estate ventures as large as some commercial properties or office buildings, giving you the option to choose your own country and currency risk associated with them.

Bonds and select preferred shares should always be used to stabilise your portfolio, as a means of generating income and preserving your capital.

Finally, diversification among asset classes and within asset classes, along with strategic asset allocation based on the stage of a client’s investment cycle, are among the best portfolio management techniques.

Jonathon Khoury is the Investment Manager at Stocks and Securities Ltd.