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What to look for when income investing

When thinking of investing, it’s natural that the potential capital gains are what spring to mind. One of the greatest benefits of shares, however, is realised when investing for income. The criteria we need to use when assessing shares for income can vary from those of a pure growth investment. Here are some of the key things to look out for.

Dividend yield

The first thing to look for when investing for income is the dividend yield. Unlike bonds, companies who pay dividends pay them out on a pence-per-share rather than a percentage basis. This means that the same dividend payment will yield a different return on your investment as its share price changes.

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This offers a great advantage. It means that a dividend-paying share, if it suffers a temporary sell-off (one which doesn’t mean reducing the dividend), can be locked in to a higher yield for you in a short space of time.

One needs to be aware, however, that dividends are not guaranteed to stay the same or even continue at all. This is why it’s important to also consider a company’s dividend history. Look for consistent payments, ideally with consistent annual growth in the dividend (otherwise inflation alone would mean the return reduces each year).

It is also the case that some companies pay dividends or increase them when it would be in their best interest to reinvest that money in the business. 

As a general rule, I find the Goldilocks dividend yield to be between about 3% and 6%. Too low and it isn’t worth it. Too high, and it probably won’t last. Market fear does offer a caveat to this however. There are occasions, if one is careful, when shares will see an unfair sell-off, usually driven by fear following bad news. In these times, a strong company can offer even higher yields.

Strong companies for income investing

The other major consideration, particularly if just investing for income, is to pick a strong company. You want your income stream to remain steady and safe, without losing your initial investment. This means going for big blue-chip firms with well-recognised brands and good finances.

These usually offer the lowest levels of capital gain, but that isn’t a problem when income investing. Even this strategy is not perfect, however. Recently, many big blue chips that had consistent dividend payments have been forced to suspend or reduce them thanks to the Covid-19 pandemic and low oil price.

It is therefore also necessary to diversify your portfolio. This is always a safe investment strategy, but admittedly one that often reduces potential capital gains. Again though, income is our main aim.

Look to have in the region of 8–12 individual investments in your portfolio. Diversify across sectors particularly, but you can also diversify across countries and even market capitalisation (if you have more risk appetite than just holding large companies).

Personally I take a mixed approach overall. Some of my investments are for income mainly, while others are for growth. Either way, income investing is something every serious investor should consider.

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Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.