Too often the media portrays the investment world as some sort of a gamble – where the poor investor is hoping that their number will come up on a roulette wheel.
Market crashes don’t help, of course – but these are relatively rare (see my earlier blog on the investment cycle – https://www.moneymaxonline.com/understanding-the-investment-cycle/.
REAL investment should NEVER be a gamble.
To the uninitiated it could be though because of how we view investment as an exit strategy, focusing on how
has it appreciated and how much can we get by selling it.
But this is a pretty short-sighted view of the markets and one that neglects the tremendous advantage of income from investing.
Investment income takes three fundamental forms: dividends, interest payments and distributions.
Dividends
Owning shares is literally owning part of a company and the benefits of that ownership accrue to you in just the same way as any other owner of a company i.e. through a portion of the company’s earnings.
To December last year, the FTSE 100 paid an annual index yield of 3.81% – that means if you had invested money at the start of the year and the FTSE hadn’t grown by even 1 point – you would have still made 3.81% in dividend income for the year.
Now just think about that for a moment… 3.81%, independent of price movement.
The other thing to note about dividends, they tend to be reasonably regular for some major companies. Remember what a big deal it was when Tesco and BP reduced their dividends for the year a couple of years ago?
From a certain perspective, some of the big blue chips can provide a regular income for you and comes with a reasonable statement of certainty.
The other handy thing to note is that inflation – the mortal enemy of income – doesn’t tend to affect dividends too much. The main reason is that companies tend to pass inflation costs on to consumers, which means that their profits tend to have some inflation proofing.
Things to pay close attention to are ‘P/E’ ratio (price to earnings ratio – high is good) and ‘EPS’ (earnings per share).
Debt Interest Payment
Most portfolios include some portion of bonds/gilts, with some bonds paying interest in the form of a coupon. Since they are loans, usually to a government or a company, you know in advance how much income to expect. They can also gain or lose value upon redemption, but if you just hold them the income is predictable.
The enemy here is twofold.
Unlike the equities mentioned above, inflation will erode the real value of the bond coupon and there is no hedge against it for bonds, unless of course you have something specifically ‘index-linked’.
Furthermore, bonds will usually have some sort of redemption date – which means you need to work out whether the price you have paid for the bond, plus the income you are receiving from the coupon, is going to be enough to cover the possible capital loss at redemption. This can be a complex equation called the ‘gross redemption yield’ and is hard to get your head around.
Things to look for include the ‘running yield’ of the bond. This is the true return vs the cost of the bond and obviously the yield to redemption mentioned above.
Distributions
You can earn income from investments that offer distributions.
Some investment vehicles, such as ‘Real Estate Investment Trusts (REITs) and US-based ‘Master Limited Partnerships’ (MLPs), are set up specifically to generate income at a steady level.
That’s not to say they are risk free, but rather the income they produce through rents and sales etc., are passed through to the investor. Owned individually, there can be tax implications with REITs and MLPs, so proceed carefully.
Funds/Collectives
In today’s markets all the vehicles we have discussed are available as funds (collectives) – either as investment trusts (companies that invest in shares) or perhaps by unitised/mutual funds which can be made up of shares, bonds, property and a few more besides.
This is helpful if you prefer a collection of income-bearing shares/bonds managed on your behalf rather than just picking out ones for yourself with all the problems that can incur.
However, as you have probably guessed, analyzing collectives, by their very nature, are different from purchasing an individual share/bond and a different approach should be taken here, especially around the total costs of the fund.
Things to look out for include the fund managers ‘Alpha’ (representing his stock picking ability) and what the present yield being produced is.
There are more exotic funds out there, as well as private equity and options-trading, but we’re moving into a more specialised area there.
Conclusion
Over the years, I’ve met many private investors in retirement who like organising their own income, with minimum help from advisors/stock brokers etc.
If you’ve got the time, a bit of knowhow and have a basic idea of what you’re looking for, then a good mix of the three groups that we’ve discussed can produce a nice income to sit alongside any other pension income you have.
If you don’t have any other income sources, then I’d probably suggest speaking to an expert to help you with creating a portfolio suitable for your objectives.
Even if you have some experience yourself, it can be a little daunting if you’re responsible for ALL your income sources. So, take a little expert advice, if for no other reason than just to make sure you’re on the right track.