Income Investing For Beginners - Guide
With interest rates at record lows for more than a decade, money left sitting in the bank generates very little return these days and, any interest which is earned, can be quickly eroded by rising inflation. Therefore, those who want to use their capital to produce additional income are forced to look elsewhere – and that is where income investing comes in.
In this article, we are going to explore the concept of income investing - an investment style which seeks to generate regular income for the investor. As well as explaining this strategy in depth, we will also provide several examples of how you can start investing for income today.
What Is Income Investing?
Income investing is an investment strategy that focuses on creating a portfolio of assets which generate income through dependable cash payouts.
The primary objective of this form of investment is to produce a regular income as opposed to investing with the goal of long term growth as is the case with many other investment strategies.
Many people may view this form of investment as more geared towards the older generations, those who have retired and are looking to preserve their capital whilst supplementing their income. However, income investing can be a valuable part of any portfolio and some of the instruments which we will look at in this article represent some of the most reliable methods of preserving wealth and beating inflation.
In the following sections, we will look at four types of investment which are commonly used to generate income by investors before looking at how you can start investing with Admirals (formerly Admiral Markets).
The first income investing vehicle we will look at are bonds. Bonds are a fixed-income investment which are issued by both governments and companies looking to raise capital. The investor essentially loans the issuing entity capital at a fixed rate of interest. The loan is then repaid in full at the bond’s maturity.
Bonds are an integral part of any income investing portfolio and are generally considered to be a lower risk investment than that of equities. However, this is not to say that they are without risk, defaults can and do happen.
Therefore, before purchasing a bond, it is important to do your research on both the issuing entity and the type of bond in question. Here are some specific things for you to consider when investing for income in bonds.
Government Bonds – Lower Risk?
Generally speaking, government bonds are seen as lower risk as a government is less likely to default on its debt than a company. However, this is not to say that it does not happen.
It is not at all unheard of for less developed countries to default on their sovereign debt in times of economic hardship. As a consequence, countries which are known to be serial defaulters tend to offer higher interest bonds – but it is important to remember that with this higher return comes considerably higher risk.
Bond Duration – Long-term or Short-term?
Another important factor to consider is the duration of the bond, which can range from anywhere from six months to a hundred years!
It may be tempting to lock yourself into a bond with a long duration and simply collect the annual interest payments until maturity, but you should be wary of doing so.
Interest rates are low now, but they are under regular review by the Bank of England. A bond yield which looks attractive today may not be so in ten or twenty years time.
Moreover, bonds are tradable on the secondary market and their value is inversely related with interest rates. In other words, when interest rates rise existing bonds lose value, conversely when interest rates are cut, existing bonds rise in value.
It is important to note, however, that if you intend to hold a bond to maturity, its secondary market value will not have any impact on your bond's interest rate or repayment amount at the end of the term. Its value will only impact you if you intend to sell the bond to a third party before it matures.
When you buy shares in a company, you are essentially buying a portion of the company in question. Because of this, some companies choose to regularly distribute a portion of the company’s earnings in cash among its shareholders. These payments are called dividends and dividend stocks are the next method of income investing which we are going to look at
Possibly the most attractive element of investing in dividend stocks is that it allows the investor to pursue two sources of potential gain: the income generated from the dividends and the appreciation of the stock’s value over time.
Regardless of what happens to the share price of the company, shareholders continue to receive dividend payments, which are distributed as a set amount per share.
However, there are some circumstances where a company may not be able to maintain their dividend payments due to the economic climate and have to suspend them for a period of time. The Covid-19 pandemic was a prime example of this, with some companies forced to preserve capital and temporarily suspend dividend payments to shareholders.
Before investing in any company, it is important to conduct a rigorous assessment of its fundamentals. If you are specifically looking at investing for income with dividend stocks, there are a few additional metrics which are important to consider.
The dividend yield shows the annualised dividend as a percentage of the current share price. For example, if the company distributed £1 per share and the current share price was £20, then the dividend yield would equal 5%.
The dividend yield is probably the most well known metric and one of the most useful when evaluating buying a dividend stock.
Generally speaking, a higher dividend yield is preferred, but anything too high may not be sustainable over the longer term.
Dividend Yield (May 2020 - May 2021)
Imperial Brands (IMB)
British American Tobacco (BATS)
Depicted: Highest yielding dividend stocks on the FTSE100. Created by author using data from dividenddata.co.uk. Date created: 28 May 2021.
The Dividend Payout Ratio
This is the dividend payout expressed as a percentage of the company’s earnings. So, for example, if a company earns £1 per share and distributes a dividend of £0.25 per share, the payout ratio would be 25%.
Human instinct may make you think that the higher the payout ratio the better, but this is not necessarily the case.
At the end of the day, income investing is seeking to create a reliable stream of income and the truth is that the higher the dividend payout ratio, the less sustainable the dividend payments will be. Equally, a lower payout ratio indicates a sustainable dividend payment.
Generally speaking, you would be looking for a dividend payout ratio of less than 50% - with the remainder being invested back into the company itself for future growth.
Earnings Per Share
Earnings per share (EPS) expresses a company's earnings as a per share value. This is an important metric to look at when evaluating income investing in dividend stocks.
Ideally you want a company whose EPS has a track record of increasing over time, as this will translate into the dividend also increasing over time.
Not only from an income perspective, a steadily increasing EPS also demonstrates the company is flourishing in their field.
A dividend stock’s payout growth can be calculated by looking at the most recent dividend payment and comparing it with historic dividend payments.
An income investor will be looking for companies which have a demonstrable track record of increasing its dividend payouts over time.
Depicted: Imperial Brands (IMB) dividend history. Chart created by author using data from dividenddata.co.uk. Date created: 27 May 2021.
ETFs and Mutual Funds
Both of these types of funds pool investor money in order to acquire a basket of securities - allowing investors to gain exposure to a variety of investments in one.
Investors can choose funds which only hold equities, bonds or a mixture of both. Moreover, there are numerous ETFs and mutual funds which actually specialise specifically in income investing. These funds will target bonds, dividend stocks and other investments and distribute the income generated to their investors.
In the following sections, we will take a look at two examples of income investing suitable ETFs; one which focuses on equities and one which instead focuses only on bonds.
SPDR S&P UK Dividend Aristocrats UCITS ETF
The SPDR S&P UK Dividend Aristocrats UCITS ETF (UKDV) is an example of a ETF which is tailored to income investing.
The UKDV ETF passively tracks the S&P UK Dividend Aristocrats Index - which is an index made up of the highest dividend yielding companies in the UK.
In order to track this index, the UKDV ETF will hold shares in all the constituent companies and income earned from dividend payments are redistributed twice a year to the ETF shareholders. According to the most recent release (30 April 2021) from the fund managers, the distribution yield among investors was 2.81%.
Depicted: Admirals MetaTrader 5 - SPDR S&P UK Dividend Aristocrats UCITS ETF (UKDV) Weekly Chart. Date Range: 8 July 2018 - 27 May 2021. Date Captured: 27 May 2021. Past performance is not necessarily an indication of future performance.
iShares JP Morgan EM Local Government Bond UCITS ETF
The iShares JP Morgan EM Local Government Bond UCITS ETF (SEML) tracks an index made up of local currency government bonds by investing directly in bonds from Emerging Markets.
As mentioned earlier, government bonds from Emerging Market countries carry greater risk, however, they also tend to offer higher interest payments. As of 25 May 2021, the distribution yield of the ETF is 4.41%.
Depicted: Admirals MetaTrader 5 - iShares JP Morgan EM Local Government Bond UCITS ETF (SEML) Weekly Chart. Date Range: 15 July 2018 - 27 May 2021. Date Captured: 27 May 2021. Past performance is not necessarily an indication of future performance.
How to Start Investing For Income With Admirals
With an Invest.MT5 account from Admirals, you can start investing for income in dividend paying stocks and ETFs!
In order to start investing, follow these steps:
- Open an Invest.MT5 account from Admirals
- Download and open the MetaTrader 5 trading platform
- Head to the ‘Market Watch’ tab on the left hand side of the screen and search for the stock or ETF which you want to buy in order to add it
Depicted: Admirals MetaTrader 5 - Market Watch
- Right click on the symbol and select ‘Chart Window’ to bring up the price chart
Depicted: Admirals MetaTrader 5 - Imperial Brands PLC Weekly Chart. Date Range: 13 September 2015 - 27 May 2021. Date Captured: 27 May 2021. Past performance is not necessarily an indication of future performance.
- Select ‘New Order’ at the top of the screen in order to bring up the order window. Here you can select the number of shares you wish to purchase
Depicted: Admirals MetaTrader 5 - Imperial Brands PLC - New Order
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.