Investor Education

Episode 3 - Investing for income and capital appreciation

Know more

What is income investing?

  • Income investing seeks primarily to generate a regular stream of payments.
  • Ideally, this income stream should outpace inflation.
  • Along with regular income, this strategy also seeks capital appreciation, which is key to long-term wealth creation.
  • With these goals in mind, investors often look at the opportunities in income-producing investments or an income-investing portfolio.

Types of income-producing investments

  • An income-investing portfolio could include a mix of different income-producing assets, such as bonds, dividend stocks and real estate.
  • Bonds give a steady income stream and stability to a portfolio, while dividend stocks can provide higher yields and potential for capital appreciation.
  • Real estate could deliver a steady stream of rental income, along with the potential for capital appreciation.

Dividend stocks

  • Dividend stocks are shares of companies that pay out a portion of their profits as dividends.
  • High-quality dividend paying companies provide a relatively reliable income stream, and dividends could increase over time.
  • The “dividend yield” is an estimate of the dividend-only return of a stock investment.
  • Investors see a dividend payment as a sign of a company's strength. Companies that have a stable dividend payment history are often viewed as financially stable and reliable.
  • This stability is often seen as an indication of a company's ability to generate consistent revenue and profits.
  • Investors should remember that dividends are discretionary; while infrequent, companies can reduce or even cancel their dividend at any time depending on the financial circumstances.

Source: Bloomberg, as of July 31, 2024.

Bonds

  • Bonds are securities that companies issue to public investors paying guaranteed regular interest payments.
  • Bonds are generally considered less volatile than stocks; thus, they can reduce overall portfolio risk and help to preserve capital.
  • Bond yield is the return an investor realizes on an investment in a bond.
  • Default risk refers to the chance that a bond issuer would fail to repay its debt or make interest payments.
Types of bonds Highlights
Government bonds Government bonds are the safest type of bonds.
Corporate bonds Corporate bonds, issued by businesses to borrow money, in general offer higher yields but are riskier. 
Municipal bonds Municipal bonds, or munis, are issued by local and state governments and certain utilities. Munis’ yields are usually modest, but the fact that the bonds are often exempt from federal and state taxes translates into higher effective returns.
High-yield bonds High-yield bonds are issued by companies with lower credit ratings. They tend to offer more attractive yields, but the risk of default is also higher. 

Real estate

  • Real-estate investment trusts (REITs) are companies that own and operate income-producing properties, from apartment buildings to office buildings to shopping malls.
  • They distribute most of their rental income to investors as dividends.
  • Rental properties that you own directly can also deliver income or rental yield. 

Capital appreciation and the concept of total returns

Capital appreciation

  • Capital appreciation is an increase in the price or value of assets.

  • It may refer to appreciation of company stocks or bonds, or an upward revaluation of fixed assets.

  • For example, if an investor buys a stock for $10 per share and the stock price rises to $12, the investor has earned $2 in capital appreciation.

Total return

  • Total return considers not only the price change but also any income generated by the asset during that period.

  • This income could be dividends from stocks, interest payments from bonds or rental income from real estate.

  • For example, an investor buys shares of Company A, and the share price increases 20% in one year. Since Company A also paid a dividend during the year, adding in the stock's yield of 3.5% to the price change, the total return is 23.5%.

  • Total return = (ending value – starting value) + income in that period.

  • Taking a long-term perspective, the total return of a stock market index can look very different from its price appreciation performance. Let’s use the S&P 500 as an example (see the following chart). 
Dividends included, the S&P 500 Index returned nearly 60% more in the past 10 years

Source: Bloomberg, as of July 31, 2024. Past performance is not a guide to future returns.

"Conclusion: It is important for investors to take a holistic view of their investments by looking at both income and capital appreciation potential for each investment. Total return determines an investment's true growth over time. "