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Investing for Income -- Don't Make These Common Mistakes

by YOURNAME



With the stock market below its 1999 high and possibly going much lower, many investors are looking for alternatives, and thinking about investing for income. This is good news for them, but there are some pitfalls for the unwary.

Income Investing Mistake #1

Thinking that all income investing is the same as "fixed" income investing.

Many income investments, especially bonds, pay a fixed rate of return. That is, if a bond pays 5% of its face value now, it's going to continue to pay 5% of its face value next year, and until it's called or ends its term.

People thinking about buying stocks for their dividend income too often look at today's dividend yield, and cringe at how small it is. They unconsciously assume dividends don't change (like bond interest), and forget to think about the future. 

However, stock dividends tend to go up. The stocks on the Mergent Broad Index have raised their dividends every year for at least 10 years -- some for over 100 years. The rate my differ, but over time stock dividends "catch up" to bond interest, and you get more money.

Income Investing Mistake #2

Not allowing for inflation.

There is certainly a place for bonds and other fixed income investments in every income investor's portfolio, because they tend to pay higher yields on their interest than stocks do on their dividends. Plus, high quality bonds (especially U.S. Treasuries) are perceived as safer than stocks.

However, a bond's interest never goes up. What seems like a high income today, won't buy nearly as much in 10 years -- and will be laughable in 20 or 30.

Yet many people who are now 65 years old will still be alive -- and wanting to buy three meals a day -- 20 or 30 and even more years from now.

Stock dividends are much more likely to go up with inflation, because companies raise their product prices over time. Plus, there is a little-known bond issued by the U.S. Treasury that goes up in value with inflation. These are called Treasury Inflation Protection Securities (TIPS), and are not as popular as they should be. 

Income Investing Mistake #3

Not getting started as soon as possible.

Too many people suffer from "paralysis by analysis." They want to know any and every little thing before they take action. How can they possibly invest their money in the stock market until they know more than most professors with PhDs in Finance?

This tendency is often encouraged by financial writers who advise readers to subscribe to the Wall Street Journal, Barrons, Money Magazine, Value Line -- and every other financial publication. And oh yes, read all the finance websites you can find. And ask questions on the discussion boards. And read all the books (there're only a few thousand of them), and so on.

The truth is, the most successful investors are putting their money into a variety of stocks that pay high dividends, and spending their spare time learning how to make or save money, so they have even more money to invest.




1. Dividends are so low, they're a joke. Why should I invest for such a small return on my money?

If you buy only stocks in the Mergent index, you'll get quality companies that have raised their dividends every year for at least 10 years -- some of them for over 100 years.

Besides, dividends are no longer as small as they were during the peak of the dot com boom when the average S&P 500 stock paid under 1%. Thanks to the low stock market, you can pick up stocks that pay up to 8% or more.

2. What kinds of stock offer such high returns?

Brand name consumer stocks aren't quite that high, but offer dependability and safety -- such as Coca-Cola and McDonalds. Real estate investment trusts (REITs) are required to pay out over 90% of their cash. So are master limited partnerships (MLPs) -- which transport oil and natural gas through pipelines. Utility companies are the traditional widows and orphans stocks, because they pay dividends and are so safe.

3. What if the economy goes into another Great Depression?

Every company would suffer, no doubt about it. And people would not be able to pay higher rents, they wouldn't use as much electricity and they wouldn't go out to eat as much. Companies that pay dividends might have to reduce them, or not raise them as much as they'd like.

However, unless a universal catastrophe sends the entire world back to the Stone Age (and if that happens, you won't care about your stock portfolio's performance anyway), people are still going to turn on electric lights, chew gum and buy hamburgers.

4. Everybody says that when you buy a stock and its price goes down, you've lost money. How can I avoid losing money?

Any stock you buy could go down in price at any time. Income investors don't have to care, because they still receive quarterly checks. 

5. Why shouldn't I just put my money into an index fund?

If you insist on investing for capital gains, that's the smartest way to do it. You can't pick individual winners, so go with the broad market. However, index fund holders gained nothing from 1999 to mid-2008. And the future doesn't look any better. Here're some bad signs for the future:

  1. Rising oil and other energy prices -- with political unrest, war and possible war with Iran threatening to move the price of oil even higher.

  2. Rising gold and silver prices.

  3. The sinking U.S. dollar.

  4. We're going into a U.S. presidential election -- and the leading candidate wants to eliminate the tax cuts that fueled the prosperity we've experienced since 2003 and pass new entitlement programs estimated to add $1 trillion to our budget.

  5. The baby boomer generation has started to retire, which will place enormous strains on the Social Security and Medicare trust funds, take experienced labor out of the economy and depress stock and bond prices as they sell off their portfolios.

  6. Terrorists still want to convert the entire world to their version of Islam.

Index fund advocates say that in the long run the market will go up because our capitalist economy creates wealth. I support the sentiment, because I strongly support capitalism. I just don't see any guarantees from God that capitalism will triumph, or that human progress has to continue.

We've seen a lot of scientific advancement, social progress and wealth creation over the past 500 years. But we've also seen periods of human history, such as the fall of the Roman Empire, where previous gains were erased -- for hundreds of years.

If the terrorists succeed in setting off a nuclear bomb, it could be many decades before the U.S. stock market can rise above current levels.

I'm not going to say this is going to happen, but none of us has any guarantee it won't. 

6. Dividends are only for rich people who inherited a bunch of stock. I need to get rich in a hurry.

It's true that you're not going to receive a million dollars a year in dividend income unless you're starting out with at least $20 million. However, investing is not -- and never has been -- a way to get rich quick. People who try it usually lose their money.

If you want to speed up the process, you must start a business of your own that solves problems for many people. If you think they're shortcuts to such success, you'll lose your money to the many con artists that prey on people like you.

7. The stock market is so low, and may go lower -- I'm afraid of it. What should I do?

Realize that this is the best income investing opportunity to come along in a long time. Because stock prices are so low, there're many opportunities to pick up brand names, utilities, Canadian income trusts, master limited partnerships and real estate investment trusts at bargain prices.

Now is the best time in years to lock in high -- and ever-growing -- dividend yields.




SUMMARY

With today's financial markets as uncertain and unstable as they are, traditional buy and hold, and pick winning stocks, strategies don't promise much return. You must rely on luck, and that's not reliable over the long term. Stocks have gone nowhere since 1999. Yet people who invest for income have received regular quarterly dividends.


KEYWORDS

investing for income, income investing, income investor, income investments, dividends, income investment, dividend, stock investing, dividend investing, stock dividends, invest for income



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