Investing for income — not just growth

GROWTH IS USUALLY THE MAIN POINT of an investing strategy. But, depending on your goals, income-producing investments may be equally if not more important. From supplementing retirement spending and funding a second home purchase to helping to pay for college and more, a portfolio that produces a steady stream of cash can be life-changing.

But putting the strategies in place to pursue that income takes thoughtful, dedicated planning. “Investing for income requires you to think differently about your assets, especially in volatile interest-rate environments,” says Matthew Diczok, head of fixed income strategy in the Chief Investment Office for Merrill and Bank of America Private Bank. Both dividend-paying stocks and bonds play a role.

By offering regular payments to shareholders, dividend-paying stocks can be a source of steady cash.¹ Share prices may rise or fall depending on the company’s health and outlook, but these stocks have the potential to gain value while paying reliable dividends, especially in today’s market, Diczok notes. “If, as expected, the market becomes less concentrated in just a few stocks, high-quality dividend stocks could benefit,” he says.

As for bonds, when you’re looking for income, what happens to prices may be less important than the interest they pay, Diczok notes. “The first and most important thing bonds provide is regular, high-quality income,” he says. And with the current interest-rate environment normalizing after prolonged volatility, anyone looking for investment income should consider taking advantage of today’s rates. “Now, taking very limited risk, you could potentially earn more than 5% on high-quality fixed income,” Diczok says. “And you could potentially earn two to three percentage points above inflation for multiple years. This is an unambiguously better time for finding sources of steady income.” (For more on the role that bonds can play in your portfolio, watch the video above.)

Below are three tactics to consider when you want to supplement your cash flow with income-paying investments. Not every strategy may be right for your particular situation. In fact, for many people, a combination of approaches may work best.

1. Streamline your income investing via mutual funds and ETFs. For the average investor, “the most cost-efficient way to build a fixed income or dividend-paying portfolio may be through ETFs and mutual funds,” says Diczok. “These funds can give you diversified access to a range of securities and cut down on transaction costs.” Compared with owning a relative handful of individual bonds, for instance, a typical bond market ETF may offer 10,000 bonds, providing very broad diversification. And with bond mutual funds, you get the advantage of fund managers who factor in various kinds of risk when selecting their holdings, Diczok says. (See chart below to learn about the many flavors of bonds available.)

2. Build a bond ladder. While bond ETFs and mutual funds may be the most convenient and cost effective way to add fixed income to your portfolio, another approach to consider is building a “bond ladder” by purchasing bonds of varying maturities, and, as Diczok notes, it can work in any type of interest-rate environment. You can create a ladder by investing in a mix of bonds with short, medium and long durations. “Most income investors want regular, reliable payments, which means owning a range of different maturities,” says Diczok. Doing so gives you predictable payments and the option to reinvest at current market rates as each bond matures. Plus, laddering helps to increase liquidity, says Diczok. The shorter-term bonds you purchase will offer access to cash as they mature, should you need it to supplement your income sooner rather than later.

3. Focus on your overall returns rather than short-term market movements. When you’re deriving the income you need from an investment, it doesn’t matter as much if the value of the underlying asset fluctuates, regardless of whether it’s a stock or a bond. “If you’re still receiving regular income and there is no fundamental change in the borrower’s creditworthiness, there’s less reason to panic if the market value of your investment goes down somewhat,” says Diczok, “especially if it’s a bond you plan to hold till maturity.”

Whatever your approach, he adds, “make sure that your portfolio includes a range of income sources that are appropriate for your goals, timelines and risk tolerance.”