Mirador Real Advice Blog

What is Income Investing?

March 15, 2024

Investing is when you take some money and buy something that you expect will provide you more than your purchase price over time. This increase that you make over what you paid comes from one or both of the following two scenarios:

  1. An appreciation in value over your purchase price (a capital gain)
  2. Payments over time, with these payments providing the primary increase in worth (interest or dividends)

The above capital gain, interest, and dividends are all considered types of investment income. 

But Income Investing is generally defined as scenario 2 above – you buy (invest in) something that pays you regular income, usually semi-annually or quarterly, and in the form of interest or dividends. The income from scenario 2 might be guaranteed interest, or it might be a dividend that is not guaranteed but is reasonably sure based on history. 

dividend

There are many reasons that people choose to invest for income:

  1. Its more comfortable to know that you are getting a return immediately and on a regular basis, rather than waiting and hoping for price gains that may or may not happen in the time frame you require
  2. Income securities tend to be less volatile so are less stressful to own. During the financial crisis of 2008 and the Covid market crash of 2020, we observed that our dividend stocks fell roughly half of what the overall indexes fell
  3. Well chosen income securities can also provide capital gains, providing some inflation protection
  4. The investment income can be re-invested and compounded to achieving significant total growth over the long term
  5. Canadian company dividends are eligible for the dividend tax credit which can make their after-tax return very attractive when held in non-registered accounts
  6. For people retired or not employed, a well managed income portfolio can provide a significant amount of cashflow for living expenses and more 

When I started as an Investment Advisor in the early 1990s, I focused solely on Investing for Income. See my blog post on higher rates for more history on this. Back then, interest rates were still relatively attractive, so my Investing for Income portfolios were all bonds. And bonds (also know as fixed income) have traditionally been the main type of investing for income securities. 

Although interest rates have increased substantially over the last two years or so, they are still not close to the interest rates of the 1990s. A 100% increase on almost nothing is still almost nothing. So today, it makes more sense for investors to focus on higher and more tax efficient dividend income. But, there could come a day when I return to my bond-buying roots and start integrating bonds into our programs. Certain economic and market circumstances would have to evolve for this to happen so that bond yields became more attractive relative to dividend yields. Even so, if I have a client with an exceptionally low risk tolerance, a portion of their total portfolio will be allocated to a conservative diversified bond portfolio, but our main focus is on our Triopay programs that provide higher yields and reduced volatility.

In addition to bonds, there are mutual funds and exchange trade funds (ETFs) that invest for income. For certain accounts at Mirador, we use ETFs like CDZ, XEI, ZPR, and ZWA, to approximately replicate the composition of our Canadian Triopay portfolios. Although the ETF yields are not as good as our programs, they have good liquidity and provide a more simple and concise way to gain exposure to the Triopay approach.

graph of income investing

I recently read an article about some high yielding investing for income Canadian ETFs. I found their approach to have too much risk. With some, their income sources were not well diversified. Others used leverage, which is a two-edged sword – it can help you excel, or it can kill you. Others had significant exposure to single sectors like real estate investment trust (REITs), which may or may not work, depending largely on the future of interest rates and the work from home trend that has severely impact commercial real estate. Other ETFs owned too many high-risk, low-quality issues whose high yields seemed to be more a result of their stock price decline, which would also make them more likely to experience dividend cuts that would likely compound the stocks’ declines. So as is often the case in the markets, if a yield sounds too good to be true, it probably is, it probably wont last.

Buying companies that are likely to increase their dividends is an important aspect of investing for income. This is called dividend growth investing. The dividend growth story seems intuitive and compelling, and we DO apply it at Mirador; your dividend income grows so your yield-on-cost increases and the stock price might also grow, giving you extra return. But you need to be careful and discerning. Let me give an example. To keep an eye on the pulse of the industry, I occasionally check out various investing websites. The other day I looked at a website that was promoting dividend growth. It was recommending a single stock that had a dividend growth of almost 1000%. Wow hey? When I pulled up the detailed company information on my Bloomberg Terminal, the current yield on this stock was less than 1%. 

Again, a thousand percent increase on almost nothing is still almost nothing, and that was what was going on here. The dividend yield for the stock at the beginning of the evaluation period was close to zero. If you bought the same stock today your yield would still be miserly, despite the huge percentage dividend growth it is still less than a savings account – hardly what you would call investing for income. And buying the stock now at the recent dividend growth rates, it would take years and years to reach a competitive dividend yield. And then, if the stock price also increased, the current yield might still be relatively low, and it might be more worthwhile to switch the increased capital value into one of your higher yielding stocks. 

You always need to take a portfolio approach to investing, no matter what your goal is. When investing for income with a portfolio approach, you need to continually look at all your holdings and ask yourself if there is a way to optimize the total current yield on your current total portfolio capital, without increasing your risk or possibly being too short-sighted regarding the potential of an existing or new, lower-yielding stock. Dividend growth is important, but it works best when the current yield is already above the median dividend yield level of the S & P TSX Index.

income growth

At Mirador we do one thing: investing for income with stability, applying our Triopay approach. Our income program is called Triopay because it is diversified across three income streams:

  1. Preferred Shares – they have preference over common shares so they are usually somewhat safer, yet they often have better yields than bonds and are more tax efficient. If rates decline, they tend to appreciate in value
  2. Equity Income – Common Stocks with financial characteristics that historically have supported higher dividend levels and even dividend increases 
  3. Covered Call Writing – see our website at miradorwealth.com for details. In summary, we have a data model that helps us sell call options to higher-risk investors. This is a low-risk strategy for us because we are like the lucrative casino taking the speculators money, earning this significant pay for our clients.

Diversification is the key method for reducing volatility. Triopay’s three “sub-folios” that source income from three different methodologies, provides the first level of diversification for our clients’ safety. Then, we further increase diversification by industry sectors and subsectors within each of the three income subfolios. Currently the Canadian Triopay has 83 securities in 27 industry sub-sectors. The largest position is 3% of the portfolio. The U.S. Triopay has 23 securities in 7 sectors. Triopay is very well diversified.

How do we select securities at Mirador? Through our own research and data modelling. My experience in the bond markets helps greatly with the preferred share selection and our Bloomberg Terminal Services provides us the data we need to create the best preferred share portfolio. The common stock securities are selected using data models that are quantitative and technical. See our website miradorwealth.com for more details on this. Mirador’s covered writing uses volatility models and technical analysis to create an inventory of possible stock candidates and then we have a three-factor model to select the best call writing opportunities.

Triopay pays a monthly income distribution. In January of 2024, we set the distribution level for Triopay at 7.5% annually. The distribution is primarily dividends, so on an after-tax basis the Triopay distribution is like having a GIC with a 9.45% interest rate.

If you would like to know more about investing for income, please reply to this email or call me at 403-608-4664.

Stan Clarke, 

Investing for Income Believer