The stock market as measured by the Dow Jones Industrial Average or Standard & Poor’s 500 index still has yet to break even over the last ten years. The Standard and Poor’s &P 500 Total Return Index (Price plus Dividend Income) is down 2.2% for the ten year period ending August 31, 2009. Although past performance is not indicative of future results, clearly it is time to evaluate asset allocation.
Is now the time to diversify? While it obviously was ten years ago, now is still a good time to diversify. Growth investment are nice, but Income investments are also important. Many investors focus only on Growth of Capital during their accumulation years and then consider Income oriented investments only at retirement. The transition from Investment Accumulation to Cash Flow Generation is the cause of much stress and uncertainty. There is an important in concept that should be recognized, most investors are investing for income, whether it be for a short-term strategy or long-term purposes. The difference is when the income is spent. For a long-term strategy any earnings in your portfolio (dividends and interest) can be reinvested. For a short-term strategy current income is the goal, and diversifying into income investments may be of benefit to you. Having current income from an investment can increase the likelihood you will have more income when it is needed it to cover expenses, not considering principal and other risks (see disclaimer below).
What type of Income investments are there? Income investments break into two main categories: Debt and Equity. Income from Equities is a sharing of the cash flow of a business and the Income from Debt investments is the interest portion of a note payment received, such as a mortgage. In seeking safety of principal, investors looking for Income can invest in U.S. Government debt. Investments safe from principal decline carry another risk, the risk of purchasing power or inflation risk.
In searching for Income investments, investors have to consider decisions similar to a swimmer who is faced with only two pools to choose from: one containing a shark and the other containing a piranha. The shark can be likened to the risk of principal loss, it can happen in large bites. The piranha can be likened to inflation risk, it happens is small nibbles. Swimming in either pool is not advisable. A balanced portfolio could be allocated to strive to manage the risk of capital loss and inflation. In other words, a balanced portfolio could seek moderate growth equity investments and higher yielding debt investments. Income investments, like all investments, have risks such as interest rate risk, default risk, liquidity risk and other risks (see disclaimer below).
If your portfolio is lacking Income investments, contact your financial adviser to review your objectives and risk tolerance and educate you about investment types available and to make recommendations. In many cases, investors have simply ignored income oriented investments. The new tax laws make some Income investments more attractive, because the income from them is taxed at a “qualified” dividend tax rate, which for many tax payers is lower than ordinary tax rates.
One type of Equity Income investment that has received increased attention lately is Real Estate Investment Trusts (REITS). REITs differ in many ways from the infamous tax-shelter limited partnership popular in the late 1980s. REITS have been around since President Dwight D. Eisenhower signed the legislation creating them in 1960. According to Bank of America Equity Research, “…REITS have out performed the S&P 500 in each of the last 1, 3, 5, 10, 20, & 30 years…” Bank of America Equity Research, January 10, 2003. REITS can be as volatile as other stocks and the chance for loss is similar. Furthermore, non-traded REITs have start-up costs and are highly illiquid.
Another type of Equity Income investment is equipment leasing, oil and gas is another example. Some investors prefer paper and forest investments, royalty trusts and other income focused equities for Income. There is much more to consider in the world of investments other than simply stocks and bonds. Equity Income investments can provide variable Cash Flow, even during times of principal decline.
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