Tired of rolling the dice?


If we truly are in a period of low growth and low interest rates for the next several years, how do you invest for income? How much risk do you need to take to get a 5% yield?

The answer is not that much.

Today, many income investors tend to share the following traits:

  • Looking to generate income from their portfolio that will be at least 4%
  • Have no corporate pension
  • Are increasingly focused on capital preservation
  • Understand that 2% GICs/T-Bills are not a good long-term solution
  • Want to be tax efficient

In our discussions with clients, the general comment is that they don’t need a 10% return, they are fine with 5% or 6% returns, but they can’t have a -10% return or worse.

This type of focus leads to some new thinking on portfolio management and investment solutions.

Here is one fact that has supported this new thinking. According to a research study by BlackRock’s Richard Turnill and Stuart Reeve, 90% of U.S. equity returns over the last century have been delivered by dividends and dividend growth.

Turnill and Reeve head the global equity team for the world’s largest money manager. It kind of makes you wonder why you would ever own something that doesn’t pay any income.

Investing for income can be very simple. Only buy what has a big yield.

Sometimes that strategy can actually work, but usually in an environment where you are going from a high level of market jitters towards one of market confidence.

The problem is that big yields are usually a sign of greater risk. Either a company is paying a very high yield because they need to do so to get people to buy it, or what was once a modest yield has become a large yield because the price of the security fell a great amount.

The other problem is that with common stocks in particular, a company can easily cut or eliminate their dividend, and as with Yellow Media last year, you go from having a high yielding security to one with no yield.

I believe in five components that are needed to achieve solid income, with moderate risk:

Bonds – Any bonds with a BBB rating or better (although you can’t ever truly trust the credit agencies). All companies need to be closely analyzed on a free cash flow basis and their existing debt obligations need to be understood. No bonds are to be held with a yield to maturity of less than 2%. Bonds can be traded to adjust duration of the portfolio or to take advantage of lateral improvements in yield to maturity.

High Interest Cash – Given the low interest rate environment, it makes little sense to hold a ‘risk’ asset like a bond when risk free daily interest bank accounts will pay 1.75%. This cash component is the bedrock of the portfolio, and by having it in place, it allows for some risk in the bond portfolio to achieve a reasonable yield return.

Preferred Shares – These holdings are used primarily for the tax advantage of dividend income in a taxable account. If someone has an income of $75,000, in Ontario they will get taxed at 33% on bond interest, but just 14% on dividends. In Alberta, the number goes from 32% on interest down to 10% on dividends. While not equal in risk to corporate bonds, they are close, especially if there is some form of redemption or rate reset feature. In some cases today, the yield on preferred shares is meaningfully higher than bonds with similar risks.

Stocks – The goal is to hold dividend “payers” and dividend “growers”, and to do the work necessary to identify companies at risk of dividend cuts, very early on. According to Ned Davis Research, based on the S&P 500 from January 1972 to April 2009, the annual gain for stocks of dividend growers and dividend initiators was 8.7%. Stocks which did not pay dividends returned less than 1%. Stocks that reduced their dividends at some point, earned 0.5% per year.

To build off of this information, one would start with the requirement that all stock holdings must pay a dividend. The companies should have a dividend yield that equals or exceeds its industry group. They must be growing earnings on a forward looking basis. They must be large cap companies. They must have a history of maintaining or growing dividends. They must have a payout ratio that is reasonable as compared to their industry peers, and not exceed 80% of earnings.

A US model that has followed a similar approach, has managed to average an 11.1% annual return over the past 18 years, while having meaningfully lower volatility (a Beta of 0.7 or 30% less volatile than the overall index) than the S&P 500.

Covered Call Writing – This strategy can be complicated, but in a nutshell it lowers risk and increases income. Exactly what the income investor likes. The downside is that it will lower returns in very strong markets, so if the TSX returns 20% in a year, your portfolio might return 15%. The net result of using covered calls is that you boost the income of the portfolio, you generally outperform in down markets, you generally outperform in flat to slightly improving markets, and underperform in strong markets.

It can be achieved using some new ETFs from companies such as BMO and Horizons, or you can find some investment counsellors and brokers that have a particular expertise in this area.

One of the big positives of this strategy is that the income generated is considered capital gains for tax purposes. Not only is this a lower taxed type of income, but for those with a build up of capital losses over the years, this is one of the only ways to ensure a capital gain – effectively getting income with no tax (until you use up your losses).

Given the objectives of the investor (protect capital, boost income, more stability), this covered call option strategy can be very effective.

With these five components, you are able to have an entire investment portfolio without going out too far on the risk front with any security, but generating an income yield easily exceeding 4%. The reason is that the yield on bonds, preferred shares and common stock dividends should be close to 4% on its own. When you add on the income from covered call options, it will easily move you close to the 5% mark.

The key benefits for income investors to this approach are:income yield somewhere between 4% and 5.5% without holding high risk investments; lower volatility; better tax efficiency; total flexibility on cash withdrawals to meet personal needs.

This portfolio is almost certain to outperform the stock market in a down year but just as certainly it will underperform in a strong stock market. However, if many pundits are correct, we may not be seeing many 15%+ years in the market in the near future.

Being Prepared for Volatile Markets

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The key investing question right now is this: How do you prepare when you don’t know what is coming next?

On Tuesday the guru said the sky was falling and on Wednesday the next guru said today is the best day to get back in the market. What is coming next?

I believe that you can be invested properly without this knowledge.

It is a bit like packing for a vacation to an unknown destination if
you really think about it. Imagine your significant other says to you “I have a surprise trip planned. It will happen next week. I have arranged everything and you have the time off. Your only job is to pack for yourself – and I won’t say where we are going.”

Let’s look a little deeper.

If you are young and carefree, you may just pack for the beach. It makes the packing light, and you guess that the worst case scenario is you stay inside to keep warm. This is a risky approach if your trip ends up in the Yukon.

If you are middle aged, and a little cautious, you may underpack, but bring some warm and cold weather clothes. You will almost certainly be re-wearing your clothes often on the trip, but at least you will have some of the right clothes. Besides, if necessary you can pay through the nose to buy what you need there. You know it will be expensive but you can afford it.

If you are older, and more cautious you may just say no to the whole thing. Too much uncertainty. Of course, you may also have passed on one of the best trips of your life. If you are convinced to go, you are going to be prepared, you will pack three suitcases, one for each type of weather. It will be heavy, the new baggage fees will be expensive, but you just never know.

All three of these approaches might be right for the different individuals.

Of course, you may have some insight. After all, you have been together for years. Would the trip planner want to go someplace quiet or adventurous? Hot or cold? Where did you go last time? What was their favourite holiday? Did they mention a certain place they always wanted to go? What is the global weather picture looking like? Is this a global warming year or a deep freeze year?

Three steps to knowing when you are ready for retirement

You will try and use this insight to help determine whether to take an extra blanket or bathing suit.

You may also think about your own comfort in the elements. Do you mind wearing shorts when it is five degrees outside? People call you crazy, but you almost never wear a winter jacket. Or maybe you’ve already worn your winter jacket a couple of times this late summer. You simply don’t like the cold.

Depending on your personal comfort with the elements, you may tend to err on the side of warmth or err on the side of a smaller bag.

The fact is, the markets, just like your vacation destination, are very uncertain at the moment. We are all trying to search for clues, and you may be more confident in one direction than the other.

In my opinion, it is all of the other things that are most important for you. It isn’t so important to know the destination, but it is important to know you. Know your hopes and those of your family. Know what type of person you are. Know whether you are just fine buying your $300 hiking gear for $600 at the base camp, or whether that would be enough to ruin the trip for you. To understand how important it is to you to have all your clothes laid out for the week, or whether you are okay with a little more chaos. Do you like to travel light or do you want to have everything with you?

I truly think that the job of a financial professional today is more about making sure that you and your family are prepared properly for your goals, your needs and your fears. Especially now. If that part is taken care of, then you will be able to manage whichever market is directly ahead of us. If those goals, needs and fears are not directly driving your investment strategy and the makeup of your portfolio, it is time to review how it is being done.

Of course, if you guess right you will be further ahead than if you guess wrong, but do you really want to be guessing about your financial future in these markets – especially if your retirement is on the line? Not me. I want to be prepared for all of them.

[VIDEO] Understanding & Avoiding Emotional Investing


Getting emotional about your investment is likely to hurt your returns. Watch the video below that discusses how to avoid emotions like greed or fear when it comes to your investment decisions!

If you liked this video, read our article about The Role of Emotions in Investing or visit our Youtube Channel for more financial planning videos.

Psychology: The Role of Emotions in Investing

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Everybody seems to “know” that getting emotional about investment decisions and market fluctuations is a bad idea. However, when it comes to making investments, human psychology often plays a large role and investors have a difficult time keeping emotions out of it. It goes without saying that this type of “emotional investing” can lead to very negative consequences.

One of the most common examples of emotions posing an obstacle to smart investment decisions is when it comes to “risk tolerance.” At the first sign of discomfort, many investors run to “adjust their risk levels.” I believe that it is more prudent to avoid this temptation. Because “risk tolerance” is a concept derived from our emotions, and not our intellect, this is every bit as volatile as any human emotions.

Successful investing is to a large extent managing our emotions, which often prompt change at precisely the wrong time.

People also change their “risk tolerance” in reaction to, rather than in anticipation of, market movements, which confirm it is also a lagged response.

Another key observation is that individual investors react to market movements by altering their comfort and “risk tolerance” in line with market cycles rather than against the cycle as should be the case.

Let me explain. As stock prices rise – and especially as they rise sharply, which reduces stock value – the investor perceives that risk in those companies/markets is actually declining, when in fact it is rising.

Since price and value are inversely related, risk is greatest when prices are high; the opposite is equally true. As stock prices rise there is less and less substance supporting the advance. Hence, the curve of a rising stock market is synonymous with rising risk.

Top -performing equities and mutual funds continually demonstrate this counterintuitive trend. Remember Nortel? At its peak people could still not buy enough. And the reverse remains true, which is when the individual investor no longer wants to own stocks and it is precisely at this moment that you can be sure we’re approaching the point of maximum financial opportunity. Just ask Warren Buffett or Peter Lynch when they get excited. It’s certainly not at market tops; that’s for sure.

The following chart illustrates the importance of managing our emotions when investing. Notice that if you relied solely on your emotions, you would drive yourself out of the market just before the point of maximum financial security. As our emotions become more negative, we often forget the bigger picture:


Human nature will ensure that this trend lives on, but through us you have the opportunity to disassociate emotional investment decisions by allowing us to invest professionally and ensure long-term success.

To avoid another investment myth, read about the reasons an age-based investing strategy may not be right for you!