Why Focus on Income?

Source

It's not so much a 'light bulb' moment (when an idea suddenly clicks) but a 'flowering bulb' moment. This is the time of year when gardens are looking quite sad, apart from the spring bulbs starting to poke their green shoots through the cold soil.

When I look at my own garden, I see the shoots of the dozens of bulbs that I planted in previous years. For most of the year you don't notice them but each February they emerge again, delivering their Spring bonus of colourful flowers. And each year there seems to be more.

There's no simpler illustration of the DIY Income Investing approach.

If you are an investor (and you probably are if you got this far) and if you looked at your portfolio recently (again, you probably did), what did you focus on? Was it the current valuation? Probably it felt good if the total value went up? We all do: the portfolio valuation is a kind of score card that allows you to compare your results with other investors.

However the DIY Income Investor approach is a bit more complex - and I think a bit more helpful. The focus is mainly on income and yield, although safeguarding and growing the capital value is also a core objective (remembering Warren Buffett's Rules One and Two of investing - "don't lose money").

The advantages of this income-oriented mind-set might not be obvious, so let me explain.

1) Why Invest?

Let's go back to the beginning: why are you investing?

The ultimate reason for saving money (and not spending it now) is to enjoy spending it in the future - either yourself or your family (or your favourite charity). The reason for investing is to make it (hopefully) worth more in the future than just putting it under the mattress or in a savings account.

2) Long Term Goal

There may be many possible short-term goals for that saved and invested money but a long-term objective that we all share would be to give up work and to live comfortably in retirement - and, for most of us, probably early retirement.

It takes very little thinking to work out that to stop working you would need income to live on from somewhere. This might be a pension or it might be income from savings and investments. (Of course, you could generate income by selling investments - but that is much less easy to plan for.)

3) How Much Income?

Sticking with the 'retirement income' thought - how much will you need?

Blogger Monevator thinks that the number you need to beat is your current take-home pay: in other words, aim to build up an income stream that will replace your work income.

I think it is a bit more complex than this: you need to focus on your future expenditure, in particular looking hard at your future 'cost of living'. If you haven't really tried to squeeze down your expenditure, let me tell you - from personal experience - that there is probably a lot of 'fat' to cut. You can probably cut the cost of every area of life.

"Well", I can hear you saying, "that's not very helpful - it's hard enough to make ends meet at the moment without trying to save any more".  No-one said it's easy - but I bet it is possible to significantly reduce your annual expenditure.

And why 'squeeze until the pips squeak'? Because that reduces your future expenditure and probably brings forward by years the time you can leave the rat-race.

The funny thing is, it is not actually that hard and does not result in too much denial of pleasure. Thoughtless spending is just a form of laziness. Start off with a spreadsheet of weekly/monthly/annual expenditure and track down every main item. It can be almost a game - finding out how to do more with less: buying food, clothes and other stuff more cheaply, cheaper utilities, cheaper holidays (I went on a luxury cruise last year), cheaper driving and travel, cheaper leisure, etc.

4) Income as Insurance

Another way to look at the focus on income as a way of buying insurance against life changes:  if you were made redundant, would you have enough income to live on?

5) Easier Investment Decisions

In your journey to financial independence, the income/yield focus gives you a powerful investment tool.

Most investors start of with a kind of 'shotgun approach' with a focus on 'value' (i.e. price). They hope to find a 'multi-bagger' that will make them rich quickly. If you’re shooting for get-rich-quick schemes, you’re liable to take too many risks and lose money rather than make it. It can be a scary roller-coaster ride - leading to typical behaviour of 'buying high and selling low'. The worst part is that there is usually no coherence or plan to this style of investment.

By contrast there can be some significant psychological and practical benefits in targeting income rather than capital value. If you’re building a portfolio of income-producing assets, you’ll take a more measured, longer-term view, reinvesting income over time. Of course, there will be a whole chunk of the investment market that will not be of interest, which to some extent simplifies your search. And remembering that yield = market-perceived risk will help you to be more cautious in which income-producing assets you buy. Focusing on yield makes sure that you get 'more income bangs for your investment buck' and, importantly, helps you to compare different types of income-producing assets, including dividend shares, fixed-income bonds and cash savings.

And being more aware of risk will lead you to diversify.

For income investors, the default holding period is forever - with two provisos:

• if the income is reduced or looks unsustainable, it may be time to sell, preferably at cost price (although it is sometimes necessary to sell at a loss)
• if the capital value increases significantly, it may be better (in terms of producing more income) to sell and buy something else

Longer holding - and less 'trading' results in lower brokerage and trading fees.

6) Sleeping Better at Night

Having a multiple focus for your investments (capital and income/yield) makes it psychologically easier to deal with the 'ups and downs' of the market. So what if your portfolio is down 2% - the income is still the same: switch off and check back later.


So, back to the flowering bulbs: its too late to plant now but you can plan for next year!




I am not a financial adviser 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.