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The Dos and Don’ts Of Income Investing

I am, what you might call, an unashamed income investor. I wasn’t always a dividend investor, though.

Like most people who first start out investing, I tried a bit of this and a bit of that. I also made a few mistakes along the way. But mistakes are part of the learning process. No one ever gets it right the first time.

Over the years, I started to find that increasingly more of my portfolio was being populated by income shares. I was, perhaps unknowingly, leaning towards dividend investing.

Today, my portfolio is made up predominantly by dividend-paying shares. Choosing income shares is now a conscious decision because those are the types of shares that I am most comfortable owing.

To be a good income investor requires both patience and discipline. That is not to say that there are any magic formulas, which when applied religiously, will always guarantee success.

But over the last two decades or so, I have found that doing certain things and avoiding doing others can help me achieve my goal. Here, then, is a checklist of the dos and don’ts when investing for income.

Don’t check your shares too often. It is easy to fall into the trap of looking to see how your portfolio is doing by regularly monitoring the share price. Some people might even do it daily, if not more often. But checking prices on a daily basis, when you’re investing for the long term is a like planting a seed and inspecting it every hour. Don’t do it.

Do make a plan and don’t tinker with it. Investing is a bit like starting a garden. You can end up with a messy patch, if you buy whatever catches your eye and plonk it straight into the ground. Gardens need planning. Know what you need and what you don’t helps you to seize on the most suitable deals, and not just any old deal.

Don’t anchor on the price you paid for a share. Your focus should be on the dividends that you receive from your investment. If the dividend stream is not only intact but also growing, then your investment should be doing fine. The prevailing market price is arbitrary to everyone but you.

Do consider making adjustments to the dividend-cover in relation to the riskiness of the business. Generally, the dividends of a safe business should be covered about one-and-a-half times by profits. But for companies with less predictable earnings, the dividends should be covered more than twice by profits.

Don’t focus on the shares that everyone else is targetting. It is tempting to buy shares in companies, just because everyone is talking about them. But if everyone is talking about them, then their share prices are likely to be high. The time to buy is when companies are out of favour.

Do try to look into the future rather than focusing on the present. A 2% yield becomes a 5% yield in five years, if dividends can grow at 20% a year, assuming a constant share price. Thankfully, the share prices of companies that are seeing a fast payout growth can often move higher.

Don’t focus solely on the yield. It can be a mistake to go for the highest yielding shares, especially those that that yield significantly more than the market average. Instead, look for companies that may not have eye-popping yields but instead have reliable yields that do not depend on strong economic growth.

Do think of yourself as a capital allocator. There is no law that says you have to re-invest dividends into the companies that paid them. Sometimes it can make sense to. But if you feel that another share in your portfolio is better priced then consider diverting one company’s payout to top up a position in another.

One of Warren Buffett’s greatest strengths has been his ability to allocate capital effectively. As an income investor, you could be one too.

A version of this article first appeared in The Straits Times.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.