If you really want income, do this

Stephen Bland of The Dividend Letter explains his income investing strategy, and why he's not bothered about the recent big falls in the stockmarkets.


Dividends can give you an income in both rising and falling markets

Are you concerned about the recent big falls in the stockmarket? You don't need to be because there is a group of equity investors who care little about share price movements.

I'm Stephen Bland. I write The Dividend Letter and have been doing so for eight years now. I and my readers invest in shares in order to derive an income from the dividends paid by those companies. That is the only reason we invest this way at all.

It might be hard to believe and may require a major change in your investing outlook if you are accustomed to seeing profits as the whole point of it all, but we do not invest for that purpose. In fact, so distanced are we from the whole concept of trading shares that we never sell a share voluntarily.

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Thinking that shares exist essentially as a tool for making capital profits puts you into a psychological trap, but you don't need to be there. You become too excited if they go up, you become too despondent if they go down. If they go down seriously, as has happened recently, you may get particularly depressed, perhaps think the whole thing is just a casino and not for you, causing you to sell up at a loss in disgust, never to look at shares again.

Dividend investing liberates you from the yoke of constant share-price watching, of worrying about every little price movement and every little bit of the torrent of news that is being broadcast constantly about the market and individual companies, the world economy and the national economy. You've seen it all, I'm sure. We live in an age of information overload as far as shares are concerned, and almost all of it is of no real merit; it doesn't make you a better investor. Small investors are as poor at trading shares as they always were.

So how does dividend investing as featured in The Dividend Letter work?

Simplicity is a key feature. I build up a portfolio of higher-yielding shares by selecting one sector per month, until there are at least 15 but usually no more than 20 sectors. Some sectors may contain more than one share in the same industry. Once complete, I then start a new portfolio. The idea is that the investor holds that portfolio forever, drawing the dividend income if needed or reinvesting it in the portfolio if not. Reinvesting boosts the income that will eventually become available when required.

The major characteristics of the shares in what I call my High Yield Portfolios (HYP) are that they consist of big caps, mostly on yields above the market average at the time of selection and highly diversified in a variety of industries. Each sector requires equal investment so that none are preferred over any other.

Is this a risky way of obtaining income? Yes, all equity investments attract risk. There can never be any guarantees, neither with the all-important income nor the capital value. Companies can and do cut dividends sometimes and in the worst case they can go bust.

So why take these risks if income is the main objective? Two reasons. For some years, the yields available on an HYP have been substantially above interest rates on bank deposits. An HYP constructed now would have a start yield of around 5%. This yield premium is the trade-off for the higher risks. But more importantly, because there isn't always such a wide gap between share yields and interest rates, dividends generally have a tendency to increase long-term whereas interest rates merely fluctuate, there is no upward long-term tendency.

Note that it is the portfolio income that matters, as if it were a fund, not the individual shares. The idea is that those companies delivering dividend increases over time will more than compensate for the inevitable laggards that don't. Similarly, in the unlikely event of any holding going bust, this should be more than compensated by the remaining shares in the portfolio.

Diversification and sticking with big caps are two of my most basic criteria that try to alleviate the above two risks, though they cannot be eliminated. Big caps are in my view less likely to go bust and less likely to slash dividends than much smaller companies.

And that's all there is to it. Invest in your HYP and draw or reinvest your dividends as required, then relax, and forget about monitoring your shares or tracking news.

If that sounds like something you'd like to get working for you

Here's everything you need to know about my strategy and how to start using it yourself.

Stephen runs his own investment newsletter, The Dividend Letter, based on his successful 'High Yield Portfolio' strategy.