One thing you should always consider when choosing your investments, is what exactly are your goals or hopes from investing. But it’s not the only issue, of course. Other questions include what kind of time frame are you expecting to work to? And what kind of risk are you willing to take with your money?
It’s self-evident, that someone looking for ultra-fast growth has to make different choices than someone who’s saving up steadily for their retirement in 30 years. Here at The Motley Fool, we like long-term thinking and when looking primarily for income, I would suggest you expect to hold your investment for at least five years. Your goal is not to be an active trader — getting in and out of shares at every news story isn’t what you want.
Fast, knee-jerk buy and sell decisions can be extremely costly and the commissions you pay will take their toll on your income, even if you do manage to get your buy and sell timing right (something that’s very hard to do). I prefer holding dividend-paying shares for years and reinvesting my dividends, which will help me make the most of compound interest. For this to work to its fullest, the longer you hold the shares (and reinvest the dividends), the better the outcome.
There is some flexibility here as an income investor, with it being possible to pick either safer or riskier income stocks, or to combine both. If you’re entirely focused on income however, I’d suggest moving forward with the least amount of risk should be in your mindset.
Which strategy?
I would generally recommend picking either income or growth as your strategy, and making investment decisions with those criteria in mind. If you’re looking for growth, don’t think too much about the dividend, while if you’re looking for income, pick shares that match that criteria. But both strategies require researching your investments carefully.
Risk should also dictate the composition of your portfolio. If you have a particular love of a certain industry, then it’s possible to build up an income portfolio with just those shares. However this is always riskier than diversifying – and diversification is the strategy I would personally recommend if you’re interested in keeping your initial investment rather than risking losing it if a particular industry hits problems.
What to look for
The two main things I look for in an income investment are the dividend yield, and dividend growth. The dividend yield is somewhat self-explanatory — with income as my main goal, I want my investment to yield the highest rate possible.
There is one caveat here however – when a company offers a very high dividend, it can be a bad sign. Either the company is paying out more than it should, or it’s trying to entice investors to ignore problems elsewhere. My rule-of-thumb is to focus between the 4% and 6% range.
Dividend growth, and consistency are almost as important. I want to see that the company has been making dividend payments consistently, and that it generally increases these dividends year-on-year. This way the yield is more likely to remain consistent in the future.
It can perhaps be more of an art than science, as with much of investing, but keeping these things in mind should set you on the right path.
