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What type of income investor are you?

Updated on August 5, 2013

What type of investor are you? Based on your profile, how should you invest for income?

CAPITAL PRESERVATION

One type of income investor expects a specific amount of money to be deposited to their checking account every month. They expect their principle to be stable. They are experienced enough to know the value of all investments goes up and down, but as long as their income is very safe, they can live with the normal ups and downs of investments. I call these people “capital preservationists.”

TOTAL RETURN

Another type of income investor also expects a certain amount of income from their portfolio to be deposited into their checking account but they also want to see their principle grow at least equal to inflation and hopefully more. These investors are the most experienced and the most trained of the three groups. The common thread between these two groups is that they have enough capital invested to safely create income. The Total Return investor works their investments to create more income than just the dividend or interest. I call this group “total returners.”

SINKING FUND

The third type of income investors is a group I call “Sinking Fund” investors. These investors need income as do the other types but these folks expect to spend some of their principle every year. Again, the common element is a portfolio of investments that creates income. Plus the investments need to be safe enough that some can be liquidated or sold when the need comes up without devastating effects on the portfolio income.

HOW TO INVEST

Like I said, if I were young, I would use the SPY and ETF that mimics the S&P 500 index. I would dividend reinvest over time to build wealth while I learned about investing. But, I am not young and I already know about investing so I will not use SPY for my income investing. If you are still reading this HUB, you know the SPY pays just above a two percent dividend yield and you cannot live on that, so it is time to learn about income investing.

Once you are faced with having to replace your wages with investment income, determine your expenses then set the amount of money you expect your portfolio to deliver to your checking account every month then decide which type of investor you are.


 
 
 
 
 
Type of Income Investor
 
 
Type of Investment
Capital Preservation
Total Return
Sinking Fund
Dividend Machines
Yes
Yes
Yes
Other Dividend Stocks
No
Yes
No
Covered Calls on Dividend Stocks
No
Yes
No
Bonds
Yes
Yes
Yes

Capital Preservationists should expect to generate about four percent cash flow. If you can live on this sum and you want your portfolio to be stable, a combination of companies I call Dividend Machines with some corporate and government bonds will do the job. Do not invest in bond funds because the risk of losing capital is too great in view of the government’s monetary policy. Owning individual well laddered, short duration, discount bonds is perfectly acceptable.

Many professional investors suggest that ETF’s and Index funds are cheaper than investing in stocks and bonds yourself. I have not found that I get as good a return on these investments and I do not even know what I own. Therefore, I used a Dividend Machine and Discount Bond strategy for capital preservation type investors when I was managing other people’s money.

Total Returnists should expect a minimum of six percent cash flow with an eye toward ten percent. The growth investor must learn how to use covered calls on dividend stocks in order to achieve their goal of total return that exceeds their income needs plus their growth goals. Using covered calls on stocks you bought at a low basis in order to cash in on capital gains as well as dividends provides many advantages to an income investor’s portfolio.

Covered calls on both Dividend Machines and those dividend stocks that pay a lesser dividend allows you to take advantage of market volatility while always preserving income. Higher yielding bonds are also part of the picture for the total return income investor. If you always buy your bonds at a discount, you are highly likely to receive your interest and a capital gain when the bond matures. The only bond in my entire investment adviser experience to default was General Motors. Thank goodness I did not nor did any of my clients have all our money in GM bonds; we were not horribly hurt.

Sinking Fund investors need a portfolio with income that increases over time so that their need to tap their savings is minimal. They also need to anticipate the need to tap their principle so that they are never in a position where they have to sell a stock that is at a low but it is their only option. What if you expected $700 a share on Apple and today you have to sell it at $413. That would really hurt.

The reason dividend growth should be a priority for sinking fund investors is that these folks think they will not outlive their money but they may and that means they will be victims of inflation. Twenty five years from now just about everything will cost twice as much and that is on a normal basis. The sinking fund investor who has income that increases will have to tap their principle less often as their income should keep up with expected expense increases.


THE MONEY MADAM's TAKE

In my mind every income investor should determine which type of investor they are. Whether you manage your own investments or use an adviser, you will benefit from defining what kind of investor you are. Believe me, you adviser would greatly appreciate knowing what type of income investor you as they can invest your money better. Should own Dividend Machines where you income is expected to increase? Should you own bonds just for interest income or should you buy at a discount for capital gain? Should you use covered calls? Only you or you and adviser can decide, but this HUB should help you flesh out the big picture about income investing.

THEMONEYMADAM

TheMoneyMadam does not cover preferred securities or real estate except exchange traded REITs.

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