New to income investing? Learn about three approaches: dividends from equity holdings, interest from bonds and fixed-income securities, and income from a multi-asset portfolio. Each comes with its own potential benefits and risks.
Investing in bonds, dividend stocks, and a multi-asset income portfolio each offer unique potential benefits and risks
An income investment strategy can be customized to match an investor’s objectives and risk tolerance
Perhaps you’re looking for a way to generate steady portfolio returns during the next market downturn, or maybe you’re just seeking to further diversify your investments. Either way, income investing might complement your strategy.
Unfamiliar with income investing? The basic idea is simple: Add income-bearing assets to your portfolio. Such assets typically include bonds, dividend stocks, and funds (mutual funds and ETFs) that target income. But the strategy can also include less traditional assets such as real estate, money market instruments, and anything else that can generate yield or income.
Let’s look at three ways you can invest for income, including the pros and cons of each approach:
A bond is a financial instrument that represents a loan made by an investor to an institutional borrower, such as a company or governmental body. Think of it as an IOU in which the details of the loan—amount, interest to be paid to the investor, payment schedule, and maturity date—are preset and disclosed.
When you purchase a bond, you, the investor, are essentially loaning money to the issuer for a set amount of time at a variable or fixed rate. In return, the issuer promises to make periodic payments, and at maturity, to repay your principal to you.
What are some potential advantages?
What are some of the risks?
Another way to potentially receive income is to hold a portfolio of stocks that have historically paid dividends. A dividend is a portion of a company’s earnings distributed to shareholders in the form of cash or stock.
Although dividend stocks can often provide a regular stream of income much like bonds, equity dividends have their own pros and cons to note.
The biggest risk is volatility. During a correction, bear market, or economic recession, the value of your equity portfolio may sink. Should this happen, you might need to decide whether to hold on to your dividend stocks or reduce your exposure by selling a few shares, holding more cash, or reinvesting your money into other stocks, bonds, or different asset classes.
There’s also the risk of a company slashing or withdrawing its dividends. In a bear market or recession, some companies may need to save capital or reinvest revenues toward their own expenditures. In such cases, some companies may choose to reduce, temporarily halt, or completely do away with dividends.
If bonds represent a relatively safe approach to income investing, and dividend stocks offer a more aggressive approach, a multi-asset portfolio might represent the middle-of-the-road path for investors seeking both income and growth.
A multi-asset income approach consists of a wider and more diverse mix of dividend- and yield-targeting assets. In addition to holding bonds and dividend stocks, you might also hold a few alternative assets such as master limited partnerships (MLPs), Real Estate Investment Trusts (REITs), and short-term money market instruments.
When it comes to time horizon, each asset might have a different maturity profile, which means you may need to manage your multi-asset portfolio more actively.
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After all, your best strategy should start with you.
What are some potential advantages?
The main advantage with a multi-asset approach is that you can seek both growth and income in a way that might not be achievable with a 100% bond or dividend equity dividend portfolio. A multi-asset portfolio might include a wider mix of assets, which can further diversify your total holdings, increasing your potential for returns while tempering your portfolio’s volatility profile.
A portfolio containing a mix of stocks and bonds will inherently come with all the risks of stocks and bonds as described above. Alternative assets such as MLPs and REITs can be thinly traded at times and thus more difficult to liquidate. Plus, some alternative assets are complex instruments that should be considered only by experienced investors. For example, REITs are subject to the same risks as direct investments in real estate, including loss of principal and sensitivity to economic downturns. And money market funds, though often considered “safe,” typically don’t come with FDIC protection. Plus they can lose value and may impose sales fees or even suspend the sale of shares if the fund’s liquidity falls below the required minimum.
Stocks, bonds, or multi-asset—whatever you decide to hold in your income portfolio, it’s important to make sure your choices are consistent with your goals, time horizon, and risk tolerance. And if you’d like help in the form of an automated investment approach, consider learning more about the suite of managed portfolio products offered by TD Ameritrade Investment Management, LLC.*
Karl Montevirgen is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.
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