Whether you are planning to save up for retirement, open up a new business, or simply have a stable source of extra income – each investor has their own reason for investing. It depends on their needs on how they would invest their money and which investment would be the best for them. In this article, we are going to talk about fixed income investing.
What is fixed income investing?
Fixed income investing or fixed interest investing is an investment method that focuses on generating cash flows from investment holdings instead of making capital gains. Investing using this strategy is focused on finding securities that have regular fixed returns, as well as a guaranteed principal. These securities may include holdings such as stock dividends or preferred shares, bond interests, or similar types of accumulating cash flows.
The aim of this strategy is to invest in companies that provide a steady stream of income or in stocks that pay solid dividends.
Read more about generating profits from dividend stocks.
Fixed income investments
Unlike growth investing, most income investors focus more on older, well-established companies, which have reached a certain maturity level and are no longer able to sustain higher levels of growth. These companies generally stopped rapidly expanding their business. They choose to pay out retained earnings to provide some returns for their shareholders rather than reinvesting their earnings into themselves.
But fixed income investing is not only about finding companies that pay high dividends. It is more about finding firms that generate a high dividend yield. Dividend yield measures the actual returns that a dividend gives to the shareholder. It is calculated by dividing the annual dividend per share by its price. Income investors are usually looking for a minimum of 5-6% yield per share.
The main objective of this strategy is to find companies with sustainable dividend yields that are high enough in order to receive a significant steady source of income over the long term.
Another aspect that income investors are looking for is the company’s dividend payout history. Most companies that paid dividends steadily over the past years are more likely to continue the same trend, while companies that showed a sudden over-optimistic change in dividend payouts tend to become unsustainable in the future.
General reminders about fixed income investing
- Investors should not depend solely on dividends on which stocks they should invest in. A high dividend doesn’t automatically mean it is a good company. Since these dividends are paid directly from the company’s net income, higher dividends sometimes result in lower retained earnings. Problems may arise when the income would have been better reinvested than paid out as dividends. That is why to pick good companies for fixed income investing, investors must look and analyze the other aspects of the company and make sure it has good and sustainable fundamentals.
- Even if a company is mature enough to pay high dividends, it doesn’t mean that it would result to lower investment risk compared to normal stock investments. The common risks associated with equity safety still apply even to companies with high dividend yields. The only way to minimize these risks is to invest only in companies built with strong foundations.
- Dividend payments in most companies are taxed at the same rate as wages. Because of this, the payments tend to be taxed higher than capital gains, which can result to lower overall returns.
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