By David Beck, Managing Director, Content; Chasing-Income.com

Many advisors on the Barron’s top advisor list are agreed: it is a stretch to try to meet investor income goals by utilizing mostly income-investing strategies.

Investing for income was less complicated 5 to 10 years ago, and perhaps just after the Great Recession when yields on bonds and stocks were 5 or 6%. But that’s no longer the case as short term bond yields struggle to generate 1%.

“Five to ten years ago we would talk about the yield in the account, probably half the investor’s income would come from yield and half from return,” says Michael Klein, managing director at RW Baird.  Klein notes that he has had many clients with a 5% distribution requirement. “Historically we got numbers close to that in yield and then we got return on top of that. We had a nice total return,” comments Klein. “These days these numbers just don’t exist without taking on risk, so we do a lot of total return strategy.”

Most investors are interested in income. The challenge is with interest rates where they are because of the Fed and the general economic environment, rates are very low. What’s more, risk looms large in the equation.

“The challenge is, in order to get a higher level of income on a better yield, you have to take risk,” observes David Mabie, CFA and partner, Chicago Capital. “Risk is often not what people are looking for when they are investing in fixed income securities like bonds or money market funds.” Mabie goes on to note that the low interest rates have prompted many of his investors to take on a bit more risk.

A Temporary Shift to Total Return?

“That’s why many of our clients have shifted their focus to total return, not because they are not interested in income, but just because it is very hard to generate meaningful income without taking risk.” And, he says, even some investments that produce higher yields, like junk bonds, private loans, and others involve higher risk.

This view is shared by Michael Dembro, chief investment officer of PPG Advisors. “The only place you can go north of 4% in fixed income yield is high yield bonds or close end funds and taking on liquidity risk.”

But Malcolm Makin, CFP and president of the firm concedes that given this environment, he doesn’t have many clients who are only interested in income investing, despite having numerous clients who are over 65. He comments that because of volatility you need to stay short term. “In previous times, you could ladder bonds of 5-6-7 year-periods and that worked pretty well. From an investor’s perspective it was reasonably safe. You would get a return of 5 or 5½ % yield and you would hold the bonds until they matured. It wasn’t rocket science. “

According to Michael Dembro the strategy on bonds is to diversify the portfolio. “At this time, we are working with mutual fund companies and owning a diverse portfolio of bonds rather than laddering up individual bonds ourselves.”

But bonds are not where most top advisors are placing their bets. According to Makin, we look at our portfolios today and find the equity portion is where the greatest return will be, where the growth is.

Like others, Michael Klein of RW Baird has many of his clients, who are mostly business owners and executives, in munis because of the tax benefits.

What about stock dividends as an option? PPG Advisors does have a limited number of client investors asking about stock dividends. But there again the options are limited. In this environment, the yield on the S & P 500 is around 1.3%.

“There are only a handful of names in the dividend space you can rely on,” says Michael Dembro. Many of those with decent yields are in energy and utilities. It is not advisable, he says, to concentrate resources on just a few sectors.

In addition, he points out that there are tax considerations to take into account. “Generally, in this environment our approach is we are going to focus on selling from equities to generate income where you are dealing with long-term capital gains which are taxed at 15% to 20% compared to dividends which are taxed at ordinary income rates.”

Michael Klein of RW Baird makes clear that he can’t get his clients, many business owners and executives, to their income goals with dividends and is putting them in equities so they will not be spending down their assets. “because of that, clients are looking at a total return strategy.”

Mabie agrees. “People in retirement do want a certain level of income and they come to us to generate that income. Sometimes a portion of that income comes from total return because since the financial crisis when interest rates came down, they effectively stayed low so it’s harder to generate income people would want using only fixed income.”

Can Income Investors Cope with Risk?

Still the threat of increased risk looms large for some advisors and their investors.

“We try to council them if they want to try and reach for higher income, it will involve some risk,” comments David Mabie. He offers some alternatives like longer term bonds or preferred stock.

But Mabie is ever mindful to approach risk carefully with many clients. “If they decide they want more equity exposure or some higher risk bonds we will start in a small way to match their income needs and we will try and reach it over time.”

Mabie wants his clients to experience a taste of volatility “with a smaller number of dollars” just in case it is not going to work for them. “What we want to avoid is having people invest in stocks who are not used to it and then it turns out they don’t like the volatility.

Michael Klein echoes these thoughts. “Investors will have to be in higher risk assets than they are used to. They have to be coached or guided to the fact that at some point there will be a change. Interest rates will need to move up because of inflationary pressure.” So what happens next? “They will have to stay the course and reinvest,” says Klein. “They will have to realize there is a correction in the market. Instead of pulling out of stock, they may need to buy a little more.”

David Mabie has other cautions. He urges investors to be wary of some high dividend stock yields. With higher dividend stocks, if there is a problem with the company, it will often cut the dividend roughly coinciding with a falling stock price. Says Mabie: The dividend gets cut after the stock price falls.”

But some investors who want income may not be all that focused on only traditional income investing. “Most of our clients are not that concerned with the source of the income, whether it is dividend-paying equities, fixed income or selling off a portion of equities,” observes Michael Dembro of PPG Advisors. “

He goes on to note that investors are less concerned about how they go about generating income and more concerned that they have accumulated wealth in their lifetime. They do want to impair the wealth they have accumulated. “This is the risk that is more important to them, rather than from which types of sectors they are generating income or how.”