Benefits of Income Investing (Even If It’s Not “Needed” Today)

FIVE THINGS YOU SHOULD KNOW

1. Equity Markets – moved higher this week with U.S. stocks (S&P 500) up 1.87% and international stocks (EAFE) rising 1.21%  
2. Fixed Income Markets – rose this week with investment-grade bonds (AGG) up 0.91% and high yield bonds (JNK) up 1.32%
3. Stubborn Inflation – This week’s CPI data came in higher than expected, in a signal that the pathway to rate cuts isn’t as linear as many had hoped. The consumer price index rose 3.4% year-over-year in December, with higher housing costs driving over half of the price gain. Cleveland Fed President Loretta Mester noted that it is premature to consider cutting interest rates as early as the central bank’s March meeting.
4. Bitcoin ETF Approval – The SEC announced this week the authorization of Bitcoin-spot ETFs but were quick to state they “did not approve or endorse Bitcoin” and that “investors should remain cautious about the myriad risks associated with Bitcoin and products whose value is tied to crypto.” However, many prominent firms, most notably Vanguard, have already stated they will not allow the trading on Bitcoin ETFs on their platform.
5. Key Insight – [VIDEO & ARTICLE] Income creation within one’s portfolio is beneficial for many reasons, even if it is not needed for immediate needs. We discuss the key tangible and intangible benefits on everything from one’s performance to finding clarity.

INSIGHTS FOR INVESTORS

Intro

A common question I get from people regarding our High Income Series strategies is “What if I don’t need the income today?” It’s a great question and one that can often entail some common misconceptions, most prominently that investing in income-oriented investments can inhibit one’s return potential.

This week we’ll share some of the key benefits of investing in assets that produce income whether those are stocks, bonds or alternatives for many investors.

#1 – Income doesn’t inhibit returns, it enhances It

When it comes to investment portfolios many people subconsciously view “income” as someone distinct from, or even in conflict with total return. The reality is that income is actually a key part of one’s total return. When it comes to real estate, especially real estate directly held, people understand that rental income is a big part of their return and a beneficial one. For whatever reason this connection is lost for many when it comes to other asset classes, but is no less the case. Here are some surprising facts related to income, even when looking solely at the S&P 500 over time. First, over the history of the index dividend income has comprised approximately 32% of the total return for the index. Second, even more surprising for many is that dividend payers, growers, and initiators have solidly outperformed non-dividend-paying stocks over the past 50 years. Hartford Funds and Ned Davis looked at the period from 1973-2022 and found that the first group had averaged between 9.18% and 10.24% respectively, while non-payers had only averaged 3.95%. The chart below shows how such differences compound over time.

#2 Income Reduces Volatility

All investors have high “gains tolerances” but most investors have much lower “risk tolerances.” Furthermore, despite common perception while taking some risk is required as investor, taking more risk doesn’t necessarily equate to more return. Finding a prudent balance is key to making money while minimizing stress and remaining prepared for financial surprises.

As you can see from the chart below, not only does income play an important role in returns but also in reducing volatility even when limited to solely viewing it from an equity perspective. By investing in companies with solid cash flow and corresponding dividend policy equity investors have historically reduced their volatility (e.g. standard deviation) by approximately 25% when looking at the first two groups versus “dividend non-payers.”

Investing in income-producing assets beyond equities as part of a broadly diversified portfolio can also play a meaningful role in optimizing risk-adjusted returns. Consider the key info in the chart below that shows that an investor over the last 23 years would have achieved over 87% of the annual upside of the S&P 500 and only 63% of the volatility (and 18% less max drawdown) by taking a more diversified approach which includes many income-producing asset classes.

We’ll wrap up this point but lost in this theoretical discussion is the assumption that most investors can/would endure the drawdowns and volatility to actually achieve the returns of an all-equity portfolio by staying the course, as well as not have any needs arise during all those years that may lead to untimely distributions – both in my near 30 years of experience would be incredibly rare.

#3 Income is a Powerful Saving/Investment Tool

Another great piece of creating income as a part of one’s portfolio is the role it can play in increasing one’s ownership. If some or all of the income is not needed then every year and it’s distribution becomes a great opportunity to reinvest that income into more assets. This not only likely increases the income generation of future years, thus creating and enhancing this virtuous cycle but also increases the shares one has that can participate in potential capital appreciation as well.

Furthermore, if one’s investments are essentially/exclusively reliant on capital appreciation to realize any gains then drawbacks become very painful to stomach, and the role of income in helping one dollar-cost average to regain one’s former financial position is removed.

#4 Income as a Source of Security

Perhaps one’s plans and/or expectations are that they do not need additional income from their portfolio today, however, most would recognize that unexpected events and resulting wants/needs can arise.

By establishing a stable income stream within one’s portfolio not only are the above benefits immediate, but one also can rest a little easier knowing that if a need does arise, they are much better prepared to meet it.

Thank you as always for the thoughtful questions, as they are much appreciated for many reasons, not the least of which is helping me with ideas to share each week after over 8 years of consecutive weekly commentaries.

Have a wonderful weekend,

Tim and team at TEN Capital

DATA, JUST THE DATA

U.S. Jobless Claims – fell by 1,000 from the previous week’s revised value to 202,000 on the period ending January 6^th. This was well below market expectations of 210,000. In the meantime, continuing claims fell by 34,000.

U.S. CPI – increased by 3.4% year-on-year to 306.746 points in December 2023 which was slightly above the market’s expectations of 306.61 points.

U.S. MBA Mortgage Applications – surged by 9.9% on the first week of the year, rebounding sharply from the 10.7% slump from the previous week. The results aligned with expectations that the Federal Reserve is due to commence its rate-cutting cycle in the first quarter.

U.K. Industrial Production – fell 0.1% from a month earlier in November 2023, easing from a 0.5% drop in the prior period and against market expectations of a 0.7% rise.

Eurozone Economic Sentiment – jumped by 9.2 points to 23 in December. This marked the highest reading in ten months and was well above initial market forecasts of 11.2. In December, 37.6% of the analysts expected improvement in economic conditions for the Euro area.