Smart Income Investing: Beyond Just High Yields
Income investing isn't just about chasing the highest yields. In today's world, where interest rates are high and economic conditions are tougher, investors need to think more carefully. It's not enough to just look at the yield. You need to consider if the investment can survive when things get rough.
The Current Environment
Interest rates are high, inflation is still around, and borrowing money is more expensive. This affects income investments in several ways:
- When the cost of borrowing goes up, profits can shrink.
- When valuations aren't as cheap as they used to be, there's less room for growth and more risk of loss.
- When the underlying value of an investment isn't protected, surprises can hit harder.
What Makes an Income Investment "Quality"?
There are three key things to look for:
- Strong Balance Sheet: The investment should be able to handle downturns and have sustainable income.
- Good Valuation: A high yield isn't helpful if you're paying too much for it.
- Transparent Analysis: Don't just rely on the headline yield; look at the data and models.
Smart Income Investing
To make smart income investments, you need to shift your focus:
- Look for yields that are backed by value and have protection against downside risks.
- Be careful with high-yield investments that don't have strong margins or good dividend coverage.
- Look for investments where you're paid for taking on risk.
- Always monitor your investments actively. In this environment, things can change quickly.
Things to Watch Out For
- Rising Leverage or Asset Resets: If a company is increasing debt or issuing equity at high valuations, that can shift the risk.
- Call-Risk on Preferred Shares: If a preferred share can be called away in the near future, the upside might be limited.
- Surprises in Book Value or NAV Erosion: If asset values are marked higher than market reality, you could be blindsided.
Conclusion
Income investing is more complex in today's world. You need discipline, transparency, and a clear view of valuation, coverage, and risk. Yield alone won't make up for structural weakness. If you're looking for an income-oriented portfolio that can hold up through shocks, you need to ask if your current strategy meets those tests.
