Another article this morning about one of the hottest topics in investing these days—where to find income. Just like all things that generate “sales sizzle” for Wall Street to push on individual investors, this topic is filled with danger. Investors need to remember a couple of key points:
1. Total return comes from three sources—interest, dividends, and capital gains. Tax wise there may be differences in the source (depending on what deal Congress reaches) but at the end of the day all money is green no matter where it comes from. Focusing on only one area, like dividends or interest, can lead to disaster.
2. Wall Street is pretty good at paying people for taking risk. If investors just focus on dividends and/or interest, typically the investments that have the highest payouts are the riskiest. You can find 6,7,8%+ yields these days, but at the risk of losing 30% or more of your money. From a risk/reward standpoint that doesn’t make sense.
3. Bonds have had a massive bull run over the past few years. For that to continue, interest rates need to go down, which is unlikely as short term rates are already pretty much at zero. If interest rates eventually rise, bonds will go down in value.
If investors insist on pursuing income, the best approach is to be tactical. Should they buy high yield bonds, emerging market bonds, closed end funds, dividend stocks? Sometimes yes, sometimes no. A true tactical approach can shift to whatever area(s) are in an uptrend and avoid large losses when another area enters a downtrend.