In today’s turbulent financial climate, the advantages of a reliable and steady source of income are becoming more relevant again. After years in which the stock markets knew almost only one direction, we are currently in a phase in which this direction must first be found again. Due to the current interest rate development and the correction in the area of growth stocks, a well-tried investment strategy is coming back into focus: the income strategy.
This article looks at the intricacies of income strategies and examines their structure, advantages and disadvantages, suitable investor profiles and a comparison with non-income strategies.
Contents
What is an income strategy?
An income strategy refers to an investment strategy that focuses on generating consistent income from your investments. Typically, this is achieved through dividends from stocks, interest from bonds, and rents from real estate investments.
The main goal is to create a predictable income stream that can be used to cover living expenses, supplement retirement income, or reinvest for continued portfolio growth.
Structuring an income strategy
The core of an income strategy is diversification, which includes multiple asset classes and sectors. Bonds, stocks (especially high-dividend stocks), real estate investment trusts (REITs), and high-yield savings accounts are popular asset types.
- Government and corporate bonds are generally preferred because of their relatively lower risk and consistent payouts. While bonds have hardly been able to generate any income in recent years, especially from good borrowers, this has changed as a result of the increase in key interest rates. This asset class is thus once again becoming an essential component of any income strategy.
- Stocks of companies with solid dividend payouts offer a growth component while generating income. Where dividend stocks were one of the most important sources of income in recent years, however, they are currently losing a bit of their appeal compared to bonds, as the latter now offer attractive coupons with lower volatility again.
- Last but not least, REITs offer participation in real estate income without the need for direct real estate ownership. High-yield savings accounts and money market funds offer modest returns, but bring consistent income and liquidity to the portfolio.
The specific allocation among these options depends on the investor’s goals, risk tolerance, and market conditions.
Advantages and disadvantages of an income strategy
Advantages:
- Stable income: This is the key advantage. Income strategies provide steady, predictable cash flow, which can be especially beneficial in retirement or during financial downturns.
- Risk mitigation: income-generating investments often have lower price volatility, providing a buffer during times of market turmoil.
- Accumulation: If income is not needed immediately, it can be reinvested, accelerating portfolio growth through the compound interest effect.
Disadvantages:
- Limited capital appreciation: compared to growth strategies, income strategies may generate lower total returns over the long term because they focus more on income than capital gains.
- Inflation risk: fixed income from bonds may lose real value if inflation exceeds interest rates.
- Interest Rate Sensitivity: Bond prices are inversely related to interest rates. Rising interest rates can depress bond prices, resulting in capital losses for holders. However, these losses are only realized if the bond is sold before it matures.
The ideal investor for an income strategy
Income strategies are particularly beneficial for investors seeking a regular income, such as retirees or those nearing retirement. They may also appeal to risk-averse investors who prioritize preserving capital and earning regular income over chasing high growth.
However, it is important to remember that a well-rounded portfolio should include a mix of income and growth investments, regardless of the investor’s life stage. The ratio may change depending on the individual’s needs and market conditions, but having both components helps maintain balance and potential returns.
Reading Tip: Retirement planning in Switzerland: How your financial security works
Income-oriented strategy vs. non-income-oriented investment strategy
When comparing income strategies to non-income strategies, two main aspects are examined: returns and volatility.
- Returns: Over long periods of time, growth strategies can generate higher total returns due to the compound interest effect of capital gains. However, during economic downturns or volatility, income strategies may perform better because they continue to deliver returns despite market conditions.
- Volatility: Income strategies generally have lower volatility than pure growth strategies. The steady returns act as a buffer against price fluctuations, making these strategies more stable over time.
Performance Comparison
To illustrate, we look at the Swiss SPI® Index, which includes almost the entire Swiss stock market, over the 9-year period. For this purpose, we have selected three ETFs , each of which tracks the entire SPI® Index, only the mid-sized companies (SPI® Mid Cap Index) and finally only the highest dividend paying stocks (SPI® Select Dividend 20 Index). For the sake of comparability, we consider so-called return indices, i.e. dividend distributions are reinvested and are thus included in the performance of the indices.
- As can be seen in the chart below, mid-sized companies perform better in times of positive market trends. This would be comparable to a more growth-focused strategy. The broad market and dividend strategy perform very similarly during this market phase.
- During negative market phases, the growth strategy reacts the most, with the dividend strategy correcting less sharply. Thus, over different market phases, dividend strategy and growth strategy offer different advantages and disadvantages, with the former having lower volatility.
- Although the total returns of the dividend strategy and the growth strategy appear very similar over the entire period under consideration, it is important to note that dividends are assumed to be reinvested here, again generating returns. Since in a traditional income strategy, cash flows are typically paid out and consumed, the return will be lower over the entire period. However, it makes up for this with the stable and regular income.
This is a simplified illustration using Switzerland as an example. This relationship may behave differently in other markets with different sector breakdowns. However, it illustrates well the basic characteristics of income and growth strategies.
Reading tip: Market review 2022 and outlook 2023
Everon’s income strategy
Everon’s investment strategy uses stocks, bonds and real estate, as their income suitability has already been mentioned. Fixed income and Real Estate are inherently asset classes that tend to generate income streams. We select the products that are best in terms of value stability, income generation and Fees are best.
On the equity side , our proprietary selection process is applied. The key metric for high-yielding stocks is dividend yield. However, looking at this metric alone can lead to suboptimal decisions because it takes into account dividend and price data. A high dividend yield may indicate a high dividend amount relative to the price, but the low price may be so low for a reason. This situation can pose the risk of what is known as a“value trap.” This is where favorable market-to-book ratios are used to incorrectly conclude that an investment instrument is undervalued, which can ultimately lead to a loss.
Everon’s approach analyzes many criteria in addition to dividend yield to determine which stocks offer stable, above-average and slightly growing dividends with reasonable price volatility. This ensures not only stable income generation, but also stable portfolio value.
Reading tip: Factor Risk Premiums: Value, Momentum, Size and Quality in recent years
Conclusion
An income strategy can be an important tool for investors seeking regular income and lower volatility. However, like all investment strategies, it carries potential risks and may not be suitable for everyone. A well-diversified portfolio that combines elements of income and growth strategies can help investors weather varying market conditions and achieve their financial goals.
It is important for investors to understand their financial needs, risk tolerance, and investment goals before choosing an investment strategy. A well-designed income strategy can be a source of stability in an uncertain market and provide a lifeline of regular income in a turbulent sea of economic change.
Ultimately, the most successful investment strategy is one that is carefully tailored to your personal financial situation and goals. Not only will you be able to maximize your investment returns, but you will also have the peace of mind that your financial future is secure. Whether you’re approaching retirement or simply want to diversify your investment approach, an income strategy could be a wise choice.
