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What to look for when investing for income

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The criteria required from an investment are as unique as the person investing. Where one person will take high risk for high growth, another wants a balanced portfolio to see them through retirement. However there are always general guidelines that are worth considering.

Investing for income vs. investing for growth

It is worth noting that many guidelines are good rules-of-thumb when investing for either income or growth. Choosing a firm with good finances and planning to hold for a longer period of time, for example, would suit many investment strategies.

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However, when looking for income specifically, a general rule is that you forgo the potential for large, quick capital gains. Though this is not always the case, of course, minimising the risk of losing your capital is key. This usually means you also minimise the potential for rapid, exponential capital gains.

With that in mind, here are some specific things to consider when your primary consideration is income.

Hold on to your money

As I said, when investing solely for income, capital gains should not be of as much concern. However, losing your capital should be. All the income in the world won’t help if you lose your initial investment.

Personally, this means my income investments are usually larger, blue-chip companies – almost always those found in the FTSE 100. In addition I look for companies with a solid set of finances. I want to see both profit and growth having grown steadily year-on-year.

Simply put, you want a company that can afford to keep on paying its dividend.

Dividend history

This brings me to my second consideration when investing for income – the company’s dividend paying history itself. I would want to see a steady, regular payment history, with few fluctuations. A company can stop paying dividends at any time, so a good payment history is no guarantee. But it is usually an indicator of the company’s commitment to pay its shareholders. 

I also look for dividend growth year-on-year. Ideally, I want this to have been inflation-beating, usually meaning anything above 2%. Of course the higher, the better, as long as it coincides with similar profit growth for the company. It is not unknown for troubled firms to entice investors with high dividends they perhaps should not be paying out.

The yield

The final consideration is, of course, the dividend yield. A company pays out a dividend on a pence-per-share basis. This means that to measure the percentage return on your investment, you also need to look at the share price.

Luckily this opens up a lot of potential to ‘lock in’ a good dividend yield when the share price is low. Of course, why the share price is low is the key consideration. If there is a fundamental issue with a firm, then the price may keep dropping.

However, there are frequently opportunities when a stock is oversold but maintaining its dividend. A yield that was 3% when a share was doing well can become 5% when it is out of favour, even though the company has not changed its payout.

A good investment is one that suits the investor’s needs. When investing for income, however, these guidelines are a good place to start.

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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.

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