Income investing is a great way to build passive income and to secure a steady stream of cash payments for your retirement. By its very nature, it lends itself very well to compounding, as you can reinvest your dividend payments back into your portfolio. Follow these tips to build your savings and secure your future.
Total return matters more than yield
A lot of talk abound dividend stocks centers around yields. This makes sense, as the yield is a measure of value in the sense that higher yields imply more bang for your buck. But there are also reasons to be skeptical of income stocks with excessively high yields. They can be a sign that management is distributing too much money to shareholders, and not thinking about the long-term health of their business. Remember, dividends are paid straight out of free cash flow, so every dollar that goes to shareholders is a dollar that is not reinvested back into the business.
Total return is the combination of capital appreciation and dividends. A stock with a 4% yield can therefore be a better investment than a stock with a 5% yield, if the former appreciates in value, while the latter stays relatively static. This consideration is particularly important for income investors, as they are typically people who are going to hold onto stocks for extended periods of time.
Do your research
All successful investing requires research, so it seems almost redundant to say this. But when it comes to income investing, there are some particularly important metrics that you will want to look at when analyzing potential buys. One thing you will want to pay attention to is a company’s dividend history. Even though past performance is never a guarantee of future returns, a business that has paid out dividends for decades, and that consistently raises them, is significantly less likely to cut its dividends. There is an institutional imperative that drives this behavior, as management will be extremely reticent to buck the trend.
Avoid fees as much as possible
Fees have come down significantly in the last few decades. The rise of index-fund investing, as well as the proliferation of online brokerage platforms, has made investing cheaper than ever before. Looking back, the fees that were once paid seem almost ludicrous. However, they can still add up, particularly over the course of a lifetime. For this reason, you are going to want to buy and hold stocks for long time periods.
There are also significant efficiency gains when buying individual stocks yourself, rather than buying a managed fund, which will charge you a fee for the privilege of investing your money. Moreover, by taking control of your own savings, you have much more skin in the game than a money manager who typically does not. It is always better to be the captain of your own ship.
Disclosure: The author owns no stocks mentioned.
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