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I’m a huge believer in income investing, which is to say I love assets that generate income — dividends, interest, distributions and royalties — that can be reinvested to augment the growth of my portfolio. And later, perhaps, provide an income stream during my retirement.
Unfortunately, we've been in something of an income drought since the 2008 financial crisis. That's when the Federal Reserve dropped its benchmark federal funds rate to near zero in an effort to ensure functioning financial markets and cheap borrowing rates to stimulate the economy. The lingering low-interest environment has shrunk income pools like the African sun beating down on a watering hole in the dry season. For example, for most of the 2000-2009 period, the ultra-safe U.S. Treasury bond had a yield of about 4.5 percent. Today, that same investment offers about 1.5 percent. (Back in the 1970s and 1980s, that same bond was typically in the 6 percent to 8 percent range.)
Even if the Federal Reserve were to slowly raise the federal funds rate, it’s unlikely Treasury yields would rocket higher immediately. One reason: They are already notably higher than the yield other government bonds are paying. The majority of European government bonds are hovering around 0 percent yield. Currently, U.K. government bonds are paying about half a percent while Germany and France are closer to zero.
So, how should we adapt to this harsh new landscape? One strategy is to focus on growth; to invest in companies that are pouring every resource into expanding and achieving dominance in their industry. Think of companies like Netflix or Amazon. These businesses typically don’t provide income in the form of dividends because they reinvest every available dollar seeking to maintain a high rate of growth. Investors expect the share price of these stocks to rise steadily and net them a profit when they sell their shares.
Another approach is to go searching for income, looking to tap new sources of cash flow to enhance our portfolios. I call this list of potential income streams B-CRISP. Here’s how it breaks down:
Bonds: While government bond yields have nearly evaporated, there are still opportunities to generate decent interest from a variety of corporate bonds.
Closed end funds: These mutual fund-like investment vehicles have the ability to take more risk, which can potentially result in greater volatility along with higher current income.
REITs: Real Estate Investment Trusts allow investors to participate in real estate holdings by acquiring shares in a basket of properties or mortgages. They are required by law to pay out 90 percent of their earnings to shareholders as distributions.
Income commodities: The best example here is the Master Limited Partnership (MLP). These publicly traded vehicles typically invest in energy transportation and infrastructure — pipelines, refineries and storage facilities. Investors receive quarterly distributions from the MLP's revenue. Despite the volatility of the sector, as a whole MLP income has remained relatively consistent.
Stocks: Income-oriented stocks (also known as dividend paying stocks) are often shares in more mature companies with steady profit margins and manageable debt. These businesses may not be growing like wildfire but have a more predictable income stream than purely growth-oriented companies. They pay out a significant portion of their earnings in dividends. Two examples of income-oriented stocks: Lockheed Martin and Procter & Gamble.
Preferred stocks: Preferred stocks are a hybrid between stocks and bonds. Owners of preferred stock have a higher claim on the company's assets than common stock shareholders in a bankruptcy proceeding, but are placed below bond holders. Among the resulting benefits: If the company pays a common dividend, it must pay the preferred stock owners their stated dividend before paying common shareholders.
So, you see, there are still plenty of places to drill for income. You are unlikely to hit a gusher, but with some careful research, you may well create a nice flow of income from numerous sources to help irrigate and grow your portfolio in this parched time.
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