Investing For Income
Elaine Bedel established Bedel Financial in 1989 in Indianapolis.
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As a subscriber you can listen to articles at work, in the car, or while you work out. Subscribe NowIf you depend on your investment portfolio to generate income for living expenses, it has been a tough few years. Given today’s low interest rates for bonds, many investors are looking for other options. But, this often requires taking on more investment risk.
Years of low interest rates for bonds, certificates of deposit, and Treasury bills have left investors starved for income. Although rates have crept up in the last couple of weeks, they are still near record low levels. As a result, investors are feeling pressure to look beyond these fixed income investments for more attractive yields.
This creates a conundrum. Safe bonds offer measly payouts, but higher yielding investments come with significantly greater risk and volatility. What are savers to do?
A possible solution is to take a more diversified approach to income investing by adding dividend paying stocks and real estate investment trust’s (REITs) to your portfolio. Let’s take a closer look at these income-producing investments and note what to pay attention to as you perform your due diligence.
Dividend Paying Stocks
With a stock, you own a piece of a business. Given possible share appreciation as well as cash dividends, the upside potential is greater than bonds. However, the value of the stock can decrease, making the downside greater, especially in the short term. Stocks that pay high dividends are generally considered more stable when compared to other stocks. These companies pay a portion of their profit to shareholders based on the number of shares an investor owns.
What to look for: Make sure the company is generating positive earnings with no losses for the past several years and that it has a proven track record of raising dividends. Look for a high yield, but not excessively high. A dividend yield of 4 percent to 6 percent is generally considered good in today’s low interest rate environment.
Look for companies that have safe dividend payout ratios, meaning they pay out no more than 50 percent of annual profit while reinvesting the rest back into the business for future growth. Paying out too much of the profits can hurt the firm’s competitive position.
Look for recession-resistant companies that have stable cash flows with little or no corporate debt and a high return on equity (ROE), at least 12 percent. If a firm has a high ROE with little or no debt, it typically has a better-than-average business model. This provides a bigger cushion in tough times which can help keep the dividend coming.
Real Estate Investment Trusts (REITs)
A REIT is essentially a mutual fund for real estate investments that can own everything from apartment buildings to offices, malls, warehouses, and hotels. It’s just like buying stock except you are buying into a company that owns or finances real estate. Note that when you buy a REIT, you own shares in companies. You don’t personally own any of the properties.
REITs are required to pay out at least 90 percent of their taxable income to shareholders in the form of dividends, which makes them a strong income-generating investment. According to FTSE NAREIT (all REIT index), current average REIT dividend yield for all types of properties is 3.9 percent. Moreover, similar to stocks, REITs also provide the opportunity for capital appreciation.
What to look for: Focus on growth in earnings which is typically tied to high occupancy rates, increasing rents, and lower costs. Look for REITs with properties in which rents are below current market levels. This will provide you with upside potential in stable markets and downside protection in times of slow economic growth.
Research the management team. Good management teams are essential. They should be able to upgrade their properties and enhance services when needed as well as effectively reinvest cash flow and develop strategies to create new business opportunities. They should also be able to consistently complete new projects on time and within budget.
Complements — Not Substitutes!
It’s important to understand that both dividend paying stocks and REITs should serve as complements to your bonds as part of a multi-asset income strategy and not as substitutes. After all, although safer bonds are currently low yielding, they provide valuable stability to your portfolio during periods of heightened volatility. How much to allocate to these income-generating options should be based on your overall investment goals and risk tolerance.
Summary
Many investors are craving for income, but are concerned about taking on additional risk. Carefully crafting a diversified income portfolio with bonds, dividend paying stocks, and REITs, may allow investors to earn more income in exchange for a manageable increase in risk.
Anthony Bykovsky, CFA, an Associate Portfolio Manager at Bedel Financial Consulting, contributed to this article.
Elaine E. Bedel, CFP, is CEO and president of Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. She is a featured guest each Wednesday on the WTHR (NBC, Indianapolis) Channel 13 News at Noon, "Your Money” segment. Elaine’s book, "Advice You Never Asked For… But wished you had," is available on Amazon.com. For more information, visit www.BedelFinancial.com or email Elaine at ebedel@bedelfinancial.com.