Saturday 24 September 2011

10 More Tips for Income Investing

In the past I have suggested 10 'rules' for income investing and 10 steps to financial nirvana plus 10 resolutions for the new financial year.

So, continuing my theme of decaphilism (if that word even exists) here are 10 distilled tips that might be useful if you are looking for new ideas to improve your income investing.

  • 1: Income safety is key: For us income investors, nothing should be held in higher esteem than the safety of our income. After all, what's the use of a high return if it's only going to be cut a few weeks later?
  • 2: Don’t be too greedy. Beware the highest yielding shares and securities – for example, those yielding twice as much as the FTSE 100 (i.e. 7%+) 
  • 3: Have patience. For investors requiring income in retirement and not flash-in-the-pan short-term gain, it’s all about the compounding of returns for the long term. Look for dividend shares and bonds with businesses that demonstrate consistent returns on invested capital, and visible earnings streams.
  • 4: Look 'off the beaten path'. In addition to dividend shares, corporate bonds and gilts there are many other ways to earn high rates of income: preference shares, enhanced capital notes, etc.
  • 5: Do your homework and seek reliability. Read the report and accounts. Look for companies with a high and growing free cash flow – that is, money left over after all capital expenditure- as this is the stream out of which rising dividends are paid. The larger the free cash flow relative to the dividend payout the better. Beware of shares where the dividend has remained flat for several years; especially when the company has a high level of debt. Some sectors of the equity market do not depend on strong economic growth to deliver attractive returns to investors - such as pharmaceutical shares. Also, beware of companies that pay a high dividend because they have gone ex-growth. Such a position is not sustainable indefinitely.
  • 6: Be aware of the risks and diversify. Some risks may not be immediately obvious. For example, the profits and dividends of utility companies can be fundamentally affected by a decision by the regulator (in the UK).  Diversification is often said to be the first rule of investment: reducing risk is particularly important for income-seekers who cannot afford to lose large chunks of their capital.
  • 7: Shelter from tax. Most people can boost returns by a quarter by investing through an individual savings account (ISA), which can deliver tax-free income, or a SIPP (pension), where contributions attract initial tax relief.
  • 8: Be prepared to be unfashionable. Usually 'out-of-fashion' stocks have a relatively low p/e ratio. Look to invest in businesses that can provide sustainable long-term dividend growth, particularly if its growth potential does not appear to be reflected in the valuation of its shares - increasing the upside opportunity.
  • 9: Use market downturns to 'lock in' higher yields: Most investors look at a market downturn as a bad thing, but opportunities that appear in a downturn. A security's yield is a function of its price: if it pays £1 a share in dividends and trades at £20, its yield is 5%. If the same security dips to £10, the yield has risen to 10%.
  • 10: Ignore volatility - but sometimes you need to take a loss:. In the short-term, share prices are buffeted by all sorts of influences, but over longer-time periods fundamentals shine through. Always look at the reasons why the price of a holding is falling and whether you should sell. If it is just the market that is falling, then you can hold on until there is a general recovery. Or if there is a credible recovery story (like BP) you might want to hold on. But clinging to a stock that keeps on disappointing is too depressing. Sell and be done with it.

I've used a couple of sources to help to identify these tips, including The Telegraph and Seeking Alpha. But there is a risk that they are reinforcing my own bias! Anyway, the tips above help me to make decisions about my portfolio - I hope they will also help you to find higher yields that are consistent, safe and profitable.

I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.

1 comment:

  1. Indeed, patience is one of the most important attitude that we must have to succeed. It may take a long wait, but with determination and proper thinking, you will never go wrong.

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