Strategies for Investing in Stock to Provide Income - dummies

Strategies for Investing in Stock to Provide Income

By Paul Mladjenovic

Even conservative income investors can be confronted with different types of risk. Fortunately, you can carefully choose income stocks so that you can minimize potential disadvantages.

Look at income stocks in the same way you do growth stocks when assessing the financial strength of a company. Getting nice dividends comes to a screeching halt if the company can’t afford to pay them. If your budget depends on dividend income, then monitoring the company’s financial strength is that much more important.

How to pinpoint your income stock needs

You choose income stocks primarily because you want or need income now. As a secondary point, income stocks have the potential for steady, long-term appreciation. If you’re investing for retirement needs that won’t occur for another 20 years, maybe income stocks aren’t suitable for you — a better choice may be to invest in growth stocks because they’re more likely to grow your money faster over a lengthier investment term.

If you’re certain you want income stocks, do a rough calculation to figure out how big a portion of your portfolio you want income stocks to occupy. Suppose that you need $25,000 in investment income to satisfy your current financial needs.

If you have bonds that give you $20,000 in interest income and you want the rest to come from dividends from income stocks, you need to choose stocks that pay you $5,000 in annual dividends. If you have $80,000 left to invest, you need a portfolio of income stocks that yields 6.25 percent ($5,000 divided by $80,000 equals a yield of 6.25 percent).

You may ask, “Why not just buy $80,000 of bonds (for instance) that yield at least 6.25 percent?” Well, if you’re satisfied with that $5,000 and inflation for the foreseeable future is 0 or considerably less than 6.25 percent, then you have a point. Unfortunately, inflation will probably be around for a long time. Fortunately, the steady growth that income stocks provide is a benefit to you.

If you have income stocks and don’t have any immediate need for the dividends, consider reinvesting the dividends in the company’s stock.

Every investor is different. If you’re not sure about your current or future needs, your best choice is to consult with a financial planner. Flip to Appendix A for helpful financial planning and investing resources.

Diversify your stocks

If most of your dividend income is from stock in a single company or single industry, consider reallocating your investment to avoid having all your eggs in one basket. Concerns about diversification apply to income stocks as well as growth stocks. If all your income stocks are in the electric utility industry, then any problems in that industry are potential problems for your portfolio as well.