Investing for Income in 2022
With inflation rising faster than interest rates, any interest earned on money sitting in the bank is quickly eroded. Therefore, those who want to put their capital to work and produce additional income will have to look elsewhere – that’s where income investing comes in.
In this article, we will explore income investing – an investment strategy which seeks to generate regular income for the investor. We will explain how to invest for income and provide some ideas for those thinking about investing for income in 2022.
Table of Contents
What Is Income Investing?
Income investing is an investment strategy that focuses on creating a portfolio of assets which generate income through dependable cash pay outs.
The primary objective of income investing is to produce a regular income as opposed to investing with the goal of long term growth as is the case with many other investment strategies.
Traditionally, this form of investment is often viewed as more suitable for older generations, as investing for income in retirement is a popular method of preserving capital whilst supplementing income.
However, income investing can be a valuable part of any portfolio, and the instruments which we will look at in this article represent some of the most reliable methods of preserving wealth and beating inflation.
Investing for Income in 2022
So, how can you start investing for income? There are a number of financial instruments which can be used for this purpose and, in the following sections, we will examine several different ways of investing for income, before demonstrating how to invest for income in 2022.
The first income investing vehicle we will look at are bonds.
Bonds are a fixed-income investment which are issued by both governments and companies looking to raise capital. The bond purchaser essentially loans this capital to the issuing entity at a fixed rate of interest. The loan is then repaid to the purchaser in full at the bond’s maturity.
Bonds are an integral part of any income investing portfolio and are generally considered to be a lower risk investment than that of equities. However, this is not to say that they are without risk. Defaults can, and do, happen.
Therefore, before purchasing a bond, it is important to do your research on both the issuing entity and the type of bond in question. Here are some specific things for you to consider when investing for income using bonds.
Government Bonds – Lower Risk?
Generally speaking, government bonds are seen as lower risk, because governments are less likely to default on debt than a company. However, this is not to say that it does not happen.
It is not at all unheard of for less developed countries to default on their sovereign debt in times of economic hardship. As a consequence, countries which are known to be serial defaulters tend to offer higher yielding bonds – but it is important to remember that with this higher return comes considerably higher risk.
Bond Duration – Long-term or Short-term?
Another important factor to consider when investing for income is the duration of the bond, which can range from anywhere from six months to a hundred years!
It may be tempting to lock yourself into a bond with a long duration and simply collect the annual interest payments until maturity, but you should be wary of doing so.
Interest rates have been at historically low levels for many years but they are now rising in an attempt to contain inflation. A bond yield which looks attractive today in comparison to your bank’s interest rate may not appear so attractive in several years’ time.
Moreover, bonds are tradable on the secondary market and their value is inversely related with interest rates. In other words, when interest rates rise existing bonds lose value, conversely when interest rates are cut, existing bonds rise in value.
It is important to note, however, that if you intend to hold a bond to maturity, its secondary market value will not have any impact on your bond's interest rate or repayment amount at the end of the term. Its value will only be impacted you if you decide to sell the bond to a third party before it matures.
Many public companies choose to regularly distribute a portion of the company’s earnings in cash among its shareholders. These payments are called dividends and dividend stocks are the next method of income investing which we are going to look at
Possibly the most attractive element of investing for income using dividend stocks is that it allows the investor to pursue two sources of potential gains: the income generated from dividends and the appreciation of the stock’s value over time.
Regardless of what happens to the share price of the company, shareholders continue to receive dividend payments, which are distributed as a set amount per share.
However, there are some circumstances where a company may not be able to maintain their dividend payments due to the economic climate and have to suspend them for a period of time. The Covid-19 pandemic was a prime example of this, with some companies forced to preserve capital and temporarily suspend dividend payments to shareholders.
Before investing in any company, it is important to conduct an assessment of its fundamentals. If you are strictly looking at dividend stocks for an income investment, there are a few metrics which are important to consider.
The dividend yield shows a company’s annual dividend payment as a percentage of the current share price. For example, if a company distributed £1 per share and the current share price was £20, then the dividend yield would equal 5%.
The dividend yield is probably the most well-known metric and one of the most useful when evaluating the merits of dividend stock for an income investment.
Generally speaking, a higher dividend yield is preferred, but anything too high may not be sustainable over the longer term.
|Rio Tinto (RIO)||11.69%|
|Abdrn plc (ABDN)||9.78%|
Depicted: Five highest yielding dividend stocks on the FTSE100. Created by author using data from dividenddata.co.uk. Date created: 25 August 2022.
The Dividend Payout Ratio
The dividend payout ratio is the dividend payment expressed as a percentage of the company’s earnings. So, for example, if a company earns £1 per share and distributes a dividend of £0.25 per share, the payout ratio would be 25%.
Human instinct may make you think that the higher the payout ratio the better, but this is not necessarily the case.
At the end of the day, income investing is seeking to create a reliable stream of income and, in reality, the higher the dividend payout ratio, the less sustainable the dividend payments will be over the long-term. On the other hand, a lower payout ratio indicates a sustainable dividend payment.
Generally speaking, you would be looking for a dividend payout ratio of less than 50% - with the remainder being invested back into the company itself for future growth.
Earnings Per Share
Earnings per share (EPS) expresses how much a company has earned for each individual share of its stock and is calculated by dividing total earnings by the number of common shares it has outstanding. This is an important metric to consider when investing for income with dividend stocks.
Ideally you want a company whose EPS has a track record of increasing over time, as this should translate into the dividend also increasing over time.
Not only from an income investing perspective, a steadily increasing EPS also demonstrates the company is flourishing in their field.
A dividend stock’s payout growth can be calculated by looking at the most recent dividend payment and comparing it with historic dividend payments.
An income investor will be looking for companies which have a demonstrable track record of increasing its dividend payments over time.
ETFs and Mutual Funds
Both of these types of funds pool investor money in order to acquire a basket of securities - allowing investors to gain exposure to a variety of investments in one.
Investors can choose funds which only hold equities, bonds or a mixture of both. Moreover, there are numerous ETFs and mutual funds which specifically target income investments. These funds will target bonds, dividend stocks and other investments and distribute the income generated to their investors.
In the following sections, we will take a quick look at two examples of ETFs which could be used by investors looking to invest for income. The first focuses on equities, whilst the second instead focuses only on bonds.
SPDR S&P UK Dividend Aristocrats UCITS ETF
The SPDR S&P UK Dividend Aristocrats UCITS ETF (UKDV) is an example of an ETF which might be suitable for those looking to invest for income.
The UKDV ETF passively tracks the S&P UK Dividend Aristocrats Index - which is an index made up of the highest dividend yielding companies in the UK.
In order to track this index, the UKDV ETF will hold shares in all the constituent companies and income earned from dividend payments are redistributed twice a year to the ETF shareholders. According to the most recent release (31 July 2022) from the fund managers, the distribution yield among investors was 3.91%.
iShares USD Corp Bond UCITS ETF
The iShares USD Corp Bond UCITS ETF (LQDE) tracks an index which is composed of US dollar denominated investment grade corporate bonds. At the time of writing (26 August 2022), the distribution yield of the ETF is 3.29%.
How to Invest for Income
With an Invest.MT5 account from Admirals, you can start investing for income in dividend stocks and ETFs! Follow these steps in order to learn how to invest for income:
- Open an Invest.MT5 account and log in to the Trader’s Room
- Next to your account details, click ‘Invest’ to open the MetaTrader WebTrader
- Search for your desired income investment at the bottom of Market Watch on the left-hand side of the screen and drag it onto the chart
- At the top screen, select ‘New Order’, enter the desired number of shares and click ‘Buy’ to send the order to the market
Investing for Income with Admirals
The Invest.MT5 account from Admirals allows you to invest in over 4,300 shares and over 300 ETFs from 15 of the largest stock exchanges in the world! Other benefits of this account include:
- Opening an account with a minimum deposit of just €1
- Competitive transaction fees and no account maintenance costs
- Free use of the world renowned MetaTrader 5 trading platform
- Exclusive access to our Premium Analytics portal, where you can find all the latest news, economic events, market sentiment and technical insight - all at no additional cost!
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.