Manual Income Investing Today: Safety and High Income Through Diversification

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Income Investing Today details a safe alternative to the downside risks inherent in the stock market--income securities that can provide a 7% to 8% annual cash income. With this book, fixed income expert Richard Lehmann outlines income investing concepts you need to understand.
Table of contents

How do I know? Their obscurity creates opportunity for us contrarian income seekers. Many investors believe bond ETFs are a convenient way to add a basket of bonds to their portfolio. ETFs never trade at discounts.


Their sponsors simply issue more shares to capitalize on any increased demand, which means anyone who buys one of these popular vehicles always pays list price. Which is why these vehicles can have wild price swings above and below the values of their actual assets. Good for us contrarian income seekers — we can buy below fair value to maximize our yields and upside. Especially for us persistent types.

Money Money Money - How to Invest in Fixed Income? - CNBC TV18

And they make CEFs in more traditional bond flavors, too. Not familiar with preferred shares? But you can double your yields or better and actually reduce your risk by trading in your common shares for preferreds. A company will issue preferred shares to raise capital, just as it offers bonds. In return it will pay regular dividends on these shares and, as the name suggests, preferred shareholders receive their payouts before common shares. So far, so good.

The tradeoff? Less upside. But the firm recently issued Series DD preferreds paying 5. JPMorgan shareholders looking for more income may be happy to make this tradeoff. But B of A just issued some preferreds that pay a fat 5. But how exactly do we buy these as individual investors?

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Which series are we looking for again? A big problem with preferred shares is that they are complicated to purchase without the help of a human broker. After all, these funds pay up to 5. Unfortunately, many ETF buyers have little understanding of preferred shares, let alone how a particular fund invests in them.

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Should we entrust the selection of preferred shares to a mere formula baked into an ETF? Again, no! Which means a better idea is — you guessed it! Buying a discounted closed-end fund CEF is the best way to do this. Thus, anytime you own a stock that pays dividends, your principal is being invaded. We also must consider taxes. This makes total-return more tax-efficient than the income approach. This way you insulate yourself from bear markets in the first several years of retirement, which statistically pose the biggest threat to your financial future. Many lifestyles were downsized when nest eggs filled with dividend stocks crumpled.

In the years preceding the dot-com crash, dividends were out of favor with many companies, which casts doubt on as a historically representative starting point. In addition, in the prior decade, dividend yields fell while stocks ran up. Another way to look at this is that on price return alone, the investment grew times, but receiving and reinvesting dividends increased it by only 31 times from there.

Retirees can have a more diversified, lower-risk portfolio, keep more of their returns after tax, and have portfolios that last longer into retirement using a total-return approach. This theory can fall apart when markets have an extended run of bad years. And if such a run of bad years seems implausible, consider that for the 13 years ended Dec. So how do you address this risk? Investors can focus on the income part of the equation or the price part.

My position is that income-focused total-return investing has the potential to give you the best of both worlds: a source of cash flow during bad markets and a primary driver of long-term wealth appreciation. There is no meaningful difference in tax efficiency between the two approaches. Both depend on low turnover to minimize taxes. And even if bond and stock prices fall, many investments will continue to produce income in the form of interest and dividends — income that can be spent to pay the bills. Investors should first figure out how much income a security is likely to produce over the next 10 to 15 years, and generally allocate a portfolio toward those with the higher total-income potential.

Over time, particularly with equities, if the income production is of high quality and growing, you generally get the capital gains anyway.

During stock-market volatility, how would you invest $,? - MarketWatch

The dividends represented all of the positive return over that entire cycle. With some fundamental research, investors can increase the odds of maintaining and increasing cash flow through recessions. On the business valuation side, current and future cash flow dictate value. Most mature and profitable businesses generate more cash than they can reasonably reinvest in their operations.

And that excess cash should be returned to shareholders in the form of dividends.

This story originally appeared in The Wall Street Journal. Read more in the Journal Report: Encore.

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