Diversifying Your Sources of Investment Income

Income-generating investments to consider

Diversification is as important for the income portion of your portfolio as it is for the equity portion. Over a 20-year period, different types of bonds and conservative equities outperformed as inflation fluctuated with changing economic conditions. As with equities, you cannot predict which type of investment is going to outperform in a given year. By diversifying your sources of investment income, you can help reduce the volatility of your portfolio overall.

Take advantage of where we are in the economic cycle to diversify your portfolio into suitable income-generating funds in the following categories.

High Yield Bonds can deliver positive returns even when interest rates rise because:

  1. The higher current yield you can earn on high yield bonds, over government bonds, can provide your portfolio with a “cushion” against a decline in bond values.
  2. Narrowing spreads should result in increased high yield bond values, which could offset (to an extent) decreases due to rising rates. In 2008-09, there was a high risk of bankruptcies. Investors fled high yield corporate bonds to ultra-safe government bonds. This caused the spread (the amount of compensation needed to incentivize investors to buy high yield bonds over government bonds) to spike to an all time high. As the economy improves and bankruptcy risks decline, spreads should narrow as demand for high yield bonds resumes.

Dividend-Paying Equities offer an income stream and are less sensitive to interest rate fluctuations than bonds. This is partially because corporations are able to pass on the higher costs from inflation to their customers by raising the end price of their goods and services during inflationary periods. Companies are able to grow their profits along with inflation and maintain, or potentially grow, dividend payouts during inflationary periods.

Real Return Bonds are guaranteed to generate an amount that keeps up with inflation, unlike regular (nominal) bonds which can be eroded by inflation over time. A reasonable allocation to real return bonds should always be part of a long term fixed income strategy to help preserve your purchasing power.

Preferred Shares provide a highly predictable income stream in the form of tax-efficient dividends. One type is “fixed reset rate” preferred, which offer payout rates that are reset every few years so you can gain some protection from rising rates. Currently, the rates that can be earned on many high quality preferred share issues are relatively high, offering the potential for some level of cushion against any declines in value that could result from the possibility of rising rates.

Income-oriented asset classes

  • Treasury bills
  • Government bonds
  • Real return bonds
  • Dividend paying equities
  • Preferred shares
  • Corporate bonds
  • Emerging market bonds
  • High yield bonds

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