For many investors seeking to generate an income from their portfolio, there are significant challenges ahead. Inflation has moved to around 3%, and could push higher if Brexit uncertainty builds. Therefore, being invested in assets such as cash and bonds does not seem to make a great deal of sense. Both asset classes could offer negative real returns in the long run. And with property becoming less tax advantageous, shares seem to be the obvious home for income investors.
However, the recent market crash has caused many investors to re-evaluate whether shares can provide them with a consistent return. After all, volatility could cause sleepless nights – especially for retirees or people who rely on their portfolio income to pay the bills.
Dependability
Despite the risks involved with investing in shares, it is possible to generate consistent returns. One area that investors may wish to focus on in order to do so is the sustainability of a company’s dividends. While the headline dividend yield may be the first thing that income investors naturally gravitate towards, the reliability of payment may be even more important.
For example, a stock with a solid track record of having paid growing dividends may be worth much more than a cyclical company that has been somewhat ‘hit and miss’ when it comes to the payment of dividends.
Certainly, it may feel as though an investor is missing out on a couple of percent in income per year by buying lower-yielding but more reliable income stocks. However, in the long run the total yield derived from them may be higher, since they are more likely to maintain payments during recessionary periods.
Business models
Most income investors do not like to see volatility in the valuation of their portfolio. Unlike growth investors who generally do not mind if there is a ‘rollercoaster ride’, income investors would usually prefer to buy stocks that offer a more stable growth pattern.
One way of achieving this is simply to invest in low beta stocks. If a company has a beta of less than 1, it means that in the recent past it has been less volatile than the wider index. Therefore, the lower the beta, the less chance there is of a rapidly-changing share price. Similarly, income investors may wish to avoid companies which have a beta of more than 1. This indicates that their share price could move to a greater extent than the index in the medium term.
Of course, beta is an imperfect measure of volatility. Small companies that are thinly traded can have low betas, while the past is not necessarily a perfect guide to the future. However, alongside seeking out companies that have historically defensive earnings, low betas could help income investors to generate stable and more consistent total returns from their investments in the Footsie over the long run.