By Scott Ronalds
Bacon is everywhere these days. It’s in chocolate, ice cream, jam, scented candles and even toothpaste. Fast food chains, while no strangers to bacon, are jumping on the bandwagon by introducing such items as bacon sundaes (Burger King) and milkshakes (Jack in the Box). A few blocks from Steadyhand world headquarters, there’s even a new takeout window on Granville Island that has an all-bacon menu, including fish & bacon tacos and a ‘Box O Bacon’ (with rye chocolate ganache dipping sauce). You can find Neil there on Mondays, Wednesdays and Fridays.
Income has become the bacon of the investment industry. Products touting income have been the hottest sellers over the past few years. Whether bond income, dividend income, preferred share income or call-writing income, investors have an insatiable thirst for anything that kicks out a stream of income. And investment providers are more than willing to quench this thirst. Look at any list of new product launches or sales figures and income-oriented funds dominate. We’ve written about the top selling BMO Covered Call Canadian Banks ETF and iShares growing fixed income lineup. Just last week, in fact, BlackRock launched the iShares U.S. High Dividend Equity Index Fund (CAD-Hedged), which is “geared to generate income and meet investors needs.”
There’s no denying that income strategies can serve a valuable role in investors’ portfolios, especially those in or nearing retirement. Like the bacon movement, however, the income craze has gone too far. Investors overloading on income at the expense of other assets (e.g. stocks) may be disappointed with their future returns. In the stampede for income, valuation seems to be lost in many investment decisions. Consider that valuations for government bonds are as unattractive as they’ve been in decades, with the benchmark 10-year Government of Canada bond yield sitting around 1.9%, which is below the rate of inflation. Yet, the bonds are still in high demand.
Investors are advised to look carefully under the hood of income-focused products to find out how the income is being generated. It’s “total return” that’s important (interest, dividends and capital appreciation), not just an attractive yield. Indeed, in certain instances, income payments simply represent a return of capital (a portion of your original investment returned to you). It’s also important to remember that income doesn’t necessarily equate to stable cash payments and lower volatility. Securities that cut or suspend income payments tend to be heavily penalized by the market.
There are clear hazards to adding too much bacon to your diet. The same can be said for income in your portfolio.