There are many investment strategies to choose from. One tried and tested approach is ‘income investing’.
Alex Thoms, Funds Specialist at Barclays, explores how this works and how it can benefit investors.
Income investing means putting your money into assets that can generate a regular and repeatable income. When it comes to investing in shares, the income we talk about comes from dividends – a part of the profits that a company distributes among its shareholders every year. Income might also be paid as interest from fixed income investments or rental income from property.
Income investing is an option for those looking to either boost their salary or to replace it when they reach retirement. It also suits those who don’t need extra money coming in, because the income can be reinvested instead, potentially boosting your overall returns.
Many funds are specifically designed for income investors and can offer diversification across multiple securities.
There are no guarantees when it comes to dividends, however. They can be cut or stopped at any time.
Benefits of Income Investing
1. Predictable Cash Flow
The primary benefit of income investing is the ability to potentially generate a predictable cash flow, which may be appealing for investors looking for regular payouts. Share prices may rise or fall depending on the company’s health and outlook, but these stocks have the potential to gain value whilst paying reliable dividends.
2. Reduced Volatility
Income generating investments can provide a buffer against market volatility. While stock prices may fluctuate, dividend payments can remain stable, providing a steady stream of income during periods of market downturn. Companies that pay out dividends are often perceived as more financially established companies and tend to be in mature industries with a reliable cash flow.
3. Preferable Valuations
Dividend yielding stocks tend to have more favourable valuations when compared growth stocks. Dividend paying companies typically have a stable cash flow which allows them to return cash to shareholders. In contrast, growth companies often reinvest earnings to fuel growth instead of paying dividends. This difference can lead to a lower valuation for dividend yielding stocks as they are perceived as less dynamic in terms of future earnings growth.
4. Compounding returns
You can reinvest the dividend or interest payments you receive as income which can lead to compounding, which is essentially the effect on your money when you earn returns on your income. This can potentially result in enhanced returns on investment over time. This is particularly effective when you have a long-term investment horizon.
5. Diversification
Income investing can offer exposure to various asset class which helps diversify your portfolio. Diversification can help mitigate risk and enhance returns of your investments across different market conditions.
6. Mitigate Company Management Risk
Some argue that the money generated from a company is more valuable in their hand than the company’s which is a positive to income investing. When compared to growth stocks, where a company may use the majority of their capital to reinvest into the business to grow, an income yielding company may pay that money out to its shareholders.
The risk with a growth company is that management do not always spend their capital well and as a result may result in the company’s value decreasing. Income investing can minimise this risk as the capital is distributed to the investor who then have a choice with what they do with the money.
