We wrote this episode to clear up some misconceptions that we kept hearing from investors about income investing. Both adherents and detractors of an income investing approach described a process where investors built a portfolio that constantly contained the highest yielding shares. We disagree.

We understand why investors are confused. On the surface an income investing approach could be misconstrued as trying to generate the highest income possible at each point in time. In our opinion, an investor should strive to establish a portfolio that will generate a steadily growing passive income stream into the future.

There are several reasons why the highest yielding shares may not lead to higher income in the future. The first is that a dividend yield is a backward looking metric as it uses the current price and dividends that have been paid in the previous year. Those dividends represent the past and investors should always be focused on the future. It ignores the sustainability of the dividend.

It also ignores the main advantage that dividends have over other sources of income such as bonds. A dividend can grow over time if a company manages to grow earnings or transitions to a point where management decides to allocate a large percentage of cash flows to dividends. Growth can be a powerful enabler of achieving an income investor’s goals. We hope you enjoy this episode and would appreciate any feedback at [email protected]

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