Successful income investing is a buy-and-hold game; not only do you have to stick around to collect dividends, but a rising payout will also drive the stock price higher over time.
Inflation and dividend sustainability are ever-present concerns for income-seeking investors.
Although anemic economic growth and the Federal Reserve’s extraordinarily accommodative measures banished inflation worries from most investors’ minds, the central bank’s recently announced plans to gradually normalize its monetary policy has triggered concerns about rising interest rates.
On the other hand, there’s no reprieve from the threat of dividend cuts, especially in an environment characterized by subpar economic growth.
You can protect your portfolio against both risks by focusing on healthy companies that are well-positioned to grow their earnings and dividends sustainably over time. Investors should avoid shopping for the highest yields, a shortsighted strategy that entails significant risk and usually ends in heartache.
Sector diversification is also critical for income-oriented investors.
In an era where institutions drive trading volume, sectors shift in and out of favor as portfolio managers seek to deliver alpha. Owning names from a wide range of industries will ensure that at least one segment of your portfolio is always in vogue. This approach helps to preserve your nest egg’s overall value in even the most difficult of environments–invaluable peace of mind if you need to withdraw funds unexpectedly.
This balance has paid off thus far for our Lifelong Income Portfolio, which has generated an average total return of about 5 percent since its inception on June 20, 2013.
While our positions in traditional income-oriented fare such as master limited partnerships and real estate investment trusts have treaded water or are down slightly, the portfolio’s cyclical names–BHP Billiton (NYSE: BHP) Freeport-McMoRan Copper & Gold (NYSE: FCX) and Total (NYSE: TOT)–have generated an average total return of 17 percent.
With an eye toward further diversification, we’re adding two new securities to the Lifelong Income Portfolio.
To date, we’ve avoided adding exposure to bonds because this security class remains mired in a seller’s market; pension funds and other institutional investors that allocate a significant proportion of their assets to fixed income have to buy whatever bonds are available.
In this environment, bond yields often fail to compensate investors appropriately for the credit and interest-rate risk that will likely unfold over the next few years.
Consider that Enterprise Products Partners LP’s (NYSE: EPD) 7.034 percent bonds maturing Jan. 15, 2068, offer a yield to maturity of 4.424 percent. Although we like the midstream operator’s long-term prospects, who wants to lock up their money until 2068 to earn an annual return of 4.424 percent on a bond issued by a company with a BBB- credit rating?