What Your Dad Never Told You About Income Investing: Q & A

One of the biggest mistakes investors make is to ignore the "income purpose" portion of their investment portfolios... many don't even realize that there should be such a thing.The second biggest mistake is to examine the performance of income securities in the same manner as they do "growth purpose" securities (equities).

The following Q & A assumes that portfolios are built around these four great financial risk minimizers:

  • All securities meet high-quality standards, produce some form of income, are “classically” diversified, and are sold when "reasonable" target profits are achieved.

1. Why should a person invest for income; aren't equities much better growth mechanisms?

Yes, the purpose of equity investments is the production of "growth", but most people think of growth as the increase in market value of the securities they own. I think of growth in terms of the amount of new "capital" that is created by the realization of profits, and the compounding of the earnings when that new capital is reinvested using "cost-based" asset allocation.

Most advisors don't view profits with the same warm and fuzzy feeling that I do... maybe it's a tax code that treats losses more favorably than gains, or a legal system that allows people to sue advisors if hindsight suggests that a wrong turn may have been taken. Truth be told, there's no such thing as a bad profit.

Most people wouldn't believe that, over the last 20 years, a 100% income portfolio would have "outperformed" all three of the major stock market averages in "total return"... using  as conservative an annual distribution number as 4%: The per year percentage gains:

Nasdaq = 1.93%; S & P 500 = 4.30%; DJIA = 5.7%; 4% Closed-End Fund (CEF) portfolio = 6.1%

  • *NOTE: during the past 20 years, taxable CEFs have actually yielded around 8%, tax frees, just under 6%... and then there were all the capital gains opportunities from 2009 through 2012.

Try looking at it this way. If your portfolio is generating less income than you are withdrawing, something must be sold to provide the spending money. Most financial advisors would agree that no less than 4% (payable in monthly increments) is needed in retirement... without considering travel, grandkids' educations and emergencies. This year alone, most of that money had to come from your principal.

  • Similar to the basic fixed annuity program, most retirement plans assume an annual reduction of principal. A "retirement ready" income program, on the other hand, leaves the principal for the heirs while growing the annual spending money for the retirees.

2. How much of an investment portfolio should be income focused?

At least 30% for anyone under 50, then a growing allocation as retirement looms larger... portfolio size and spending money requirements should dictate how much of the portfolio can be at risk in the stock market. Typically, no more than 30% in equities for retirees. Very large portfolios could be more aggressive, but isn't true wealth the knowledge that you no longer have to take significant financial risks?

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Disclosure: All thMy articles always describe aspects of an investment process I have been using since the 1970's, as described in my book,  more

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