Stocks, Bonds, and Multi-Asset: Exploring Three Styles of Income Investing

Stocks, Bonds, and Multi-Asset: Exploring Three Styles of Income Investing

Key Takeaways

    Income investing may be an effective way to supplement your portfolio growth strategy

    Investing in bonds, dividend stocks, and a multi-asset income portfolio each offer unique potential benefits and risks

    An income investment strategy can be customized to match an investor’s objectives and risk tolerance

Perhaps you’re looking for a way to generate steady portfolio returns during the next market downturn, or maybe you’re just seeking to further diversify your investments. Either way, income investing might complement your strategy.

Unfamiliar with income investing? The basic idea is simple: Add income-bearing assets to your portfolio. Such assets typically include bonds, dividend stocks, and funds (mutual funds and ETFs) that target income. But the strategy can also include less traditional assets such as real estate, money market instruments, and anything else that can generate yield or income.

Let’s look at three ways you can invest for income, including the pros and cons of each approach: 

    Investing in the bond marketHolding an equity dividend portfolio Taking a multi-asset income approach

1. Investing in the Bond Market

A bond is a financial instrument that represents a loan made by an investor to an institutional borrower, such as a company or governmental body. Think of it as an IOU in which the details of the loan—amount, interest to be paid to the investor, payment schedule, and maturity date—are preset and disclosed. 

Want to learn more about the bond market, the types of bonds, and bond risks? Refer to this bonds primer on The Ticker Tape

When you purchase a bond, you, the investor, are essentially loaning money to the issuer for a set amount of time at a variable or fixed rate. In return, the issuer promises to make periodic payments, and at maturity, to repay your principal to you.

What are some potential advantages?

    Low volatility. Although bond prices fluctuate like most other assets, their movements tend to be much less volatile than stocks. And unlike stocks, your aim isn’t necessarily to buy low and sell high, but rather to receive income and, hopefully, your entire principal at the bond’s maturity date.Consistency and predictability. As with any income source, it’s nice to know how much you’ll be paid, when you’ll be paid, how long you’ll be paid, and in the case of bonds, when your principal will be repaid.Laddering for longer-term income. Suppose you want to receive bond income for the next 10 years but might need to access some of your invested capital within that time. You can “ladder” your investments by allocating funds to bonds with different maturity periods, such as two-year, four-year, six-year, eight-year, and 10-year securities. When one bond matures, you can redeem the funds and use them for personal expenses, or you can reinvest, perhaps into another 10-year bond, to extend your ladder.

What are some of the risks?

Higher yields often mean higher risk. As a consumer, you know that banks typically charge higher interest on loans for borrowers with poor credit ratings. The same holds true with bonds. The lower the issuer’s credit rating, the higher the yield. But with this higher yield comes a higher risk of default by the borrower. Another risk inherent in bonds is that prices do fluctuate along with interest rates and interest rate expectations. So if you redeem a bond before maturity, it could be worth less than your purchase price.

2. Holding an Equity Dividend Portfolio

Another way to potentially receive income is to hold a portfolio of stocks that have historically paid dividends. A dividend is a portion of a company’s earnings distributed to shareholders in the form of cash or stock.

Although dividend stocks can often provide a regular stream of income much like bonds, equity dividends have their own pros and cons to note.

What are some potential advantages?

    Price appreciation. In addition to providing income through dividends, a stock can also rise in value in relative proportion to company, sector, or broader market performance. This gives you the potential benefit of portfolio growth in addition to income.Income and cash flow. Stocks tend to rise and fall more quickly than bonds. So if a dividend stock is rising, you have the choice of taking dividends for income or selling some shares to generate cash flow.Market cycle flexibility. You may find an opportunity during a market rally or downturn to accumulate more dividend stocks or to cut down on your equities exposure. Because dividend stocks can be traded intraday and are generally more liquid than bonds, they can be more flexible when it comes to managing your portfolio more intensively.

What are some of the risks?

The biggest risk is volatility. During a correction, bear market, or economic recession, the value of your equity portfolio may sink. Should this happen, you might need to decide whether to hold on to your dividend stocks or reduce your exposure by selling a few shares, holding more cash, or reinvesting your money into other stocks, bonds, or different asset classes.

There’s also the risk of a company slashing or withdrawing its dividends. In a bear market or recession, some companies may need to save capital or reinvest revenues toward their own expenditures. In such cases, some companies may choose to reduce, temporarily halt, or completely do away with dividends.

3. Taking a Multi-Asset Income Approach

If bonds represent a relatively safe approach to income investing, and dividend stocks offer a more aggressive approach, a multi-asset portfolio might represent the middle-of-the-road path for investors seeking both income and growth.

A multi-asset income approach consists of a wider and more diverse mix of dividend- and yield-targeting assets. In addition to holding bonds and dividend stocks, you might also hold a few alternative assets such as master limited partnerships (MLPs), Real Estate Investment Trusts (REITs), and short-term money market instruments.

When it comes to time horizon, each asset might have a different maturity profile, which means you may need to manage your multi-asset portfolio more actively.

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What are some potential advantages?

The main advantage with a multi-asset approach is that you can seek both growth and income in a way that might not be achievable with a 100% bond or dividend equity dividend portfolio. A multi-asset portfolio might include a wider mix of assets, which can further diversify your total holdings, increasing your potential for returns while tempering your portfolio’s volatility profile.

What are some of the risks?

A portfolio containing a mix of stocks and bonds will inherently come with all the risks of stocks and bonds as described above. Alternative assets such as MLPs and REITs can be thinly traded at times and thus more difficult to liquidate. Plus, some alternative assets are complex instruments that should be considered only by experienced investors. For example, REITs are subject to the same risks as direct investments in real estate, including loss of principal and sensitivity to economic downturns. And money market funds, though often considered “safe,” typically don’t come with FDIC protection. Plus they can lose value and may impose sales fees or even suspend the sale of shares if the fund’s liquidity falls below the required minimum.     

Stocks, bonds, or multi-asset—whatever you decide to hold in your income portfolio, it’s important to make sure your choices are consistent with your goals, time horizon, and risk tolerance. And if you’d like help in the form of an automated investment approach, consider learning more about the suite of managed portfolio products offered by TD Ameritrade Investment Management, LLC.*

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