#223 – How the Fed’s Rate Cut Could Impact Income Investors + A Deep Dive into Income Investing Strategy

Wes Moss [00:00:35]:
You’Ll never have enough money, and it’s.

Wes Moss [00:00:37]:
Almost impossible to retire early. Actually, I think the opposite is true. For more than 20 years, I’ve been researching, studying, and advising american families, including those who started late, on how to retire sooner and happier. So my mission with the retire sooner podcast is to help a million people retire earlier while enjoying the adventure along the way.

Wes Moss [00:00:59]:
I’d love for you to be one of them.

Wes Moss [00:01:01]:
Let’s get started. Income investing. Income investing in 2024 versus 2021, when we first did an overview of the philosophy of income investing right here on the retire sooner podcast. The numbers have changed somewhat in more in some categories than other categories. But the concept, the philosophy, the strategy is still very much the same. So today we’re talking about how to think about income investing, and the reason we wanted to do an updated version of this important philosophy and topic really core to how we think about investing over long, long periods of time on the retire sooner podcast is because the Federal Reserve, for the first time in nearly four years, has cut interest rates, lower interest rates. And they did so in mid September. It was the first time they’ve done that in really about four years, and they did it by a full half of a percent.

Wes Moss [00:02:13]:
They’ve lowered their target federal funds rate by a full half a percent. And if the marketplace is right, they expect, they, being the great minds of the market, all put together, they’re betting on many more cuts to come. So when that happens, when interest rates change, that can send ripples through financial markets. For investors, the shift can create opportunities, but also, of course, introduce even more uncertainty. And uncertainty, of course, is the constant that we all face when it comes to investing. So in light of the Fed lowering rates for the first time since 2020, let’s break down what typically happens to different retirement assets, stocks, bonds, cash in the wake of a rate cutting cycle. And in the latter part of the show, we’re going to go back to giving an overview of this important investing concept we call income investing. That includes stock dividends, bond interest, and a variety of other cash flows we call distributions that can come from lots of other places, like real estate, energy pipeline companies, closed end funds, preferred stocks, and the list goes on.

Wes Moss [00:03:27]:
Let’s start with stocks. Historically, when the Fed starts reducing rates, stocks do pretty well. They tend to perform well, overdose the course of the next twelve months. And this can happen for a lot of different reasons, but primarily when the Fed’s lowering rates, it reduces borrowing costs for businesses, and that can lead to stronger corporate profits if the economy holds up or even picks up steam. Again, stock markets like good economic numbers, and those good economic numbers translate back to company earnings. And again, the market typically has liked that over the course of history. Smaller companies in particular may benefit even more than larger companies. Many small companies or small caps have floating rate debt, so the borrowing costs can decline immediately when rates start to fall.

Wes Moss [00:04:25]:
That’s why if you look at the Russell 2000 index, which focuses in on smaller and mid sized companies, again, these are the publicly traded companies that’s often outperformed the S and P 500 after a rate cut. But there is maybe one catch, and I don’t know if this will happen or not, but if rate cuts are in a reaction to some sort of economic problem or downturn, like we saw in the aftermath of the.com bubble, we saw an zero eight. And of course we saw emergency rate cuts during the pandemic. The reason behind those rate cuts that can override the benefits of lower borrowing costs and lower rates and could almost foreshadow corporate profits going down and markets not liking that environment, at least as of now. Here we are in the fall of 2024. The economic numbers don’t support any sort of economic emergency. But of course, recessions are just part of economic history, and it’s not as though we’re able to avoid them completely.

Wes Moss [00:05:34]:
You may have heard me talk about income investing, and it’s a topic that I bring up a lot on retire sooner because it’s kind of the core of my entire investment life. It’s the core of my investment philosophy and has been for as long as I can remember. And I’ve been in the investment business for about 25 years now. And it is the actual core of any sort of financial plan, because when you’re meeting with families, particularly in today’s world, and I’m recording this podcast, kind of in the middle of the normal course of business, and I had a family today I’ve worked with for a very long time. And they’re worried about, they’re worried about inflation, and they’re worried about all the money that the government spent and none of that’s a secret. It’s very much out in the open. You can go online and find the United States debt clock in about a nanosecond, and it shows that we have about $28 trillion in debt. And again, I don’t know.

Wes Moss [00:06:35]:
I’ve used different analogies to that. And my kids always ask me about this, like, how much is a trillion dollars? Well, you could take a dollar bill and stack it all the way up to the moon and back 17 times. That’s kind of what a trillion dollars is. And the increase in the money supply in the US, understandably, makes each additional dollar in the US a little bit less valuable. So we have to worry about the dollars we use becoming less valuable over time and our purchasing power getting eroded. And of course, that is the story of inflation. And that’s exactly what Kathy and Charles asked me today. They said, wes, all of this money, are we going to get inflation? What is our, how do we combat that? And if you look at our retirement timeline, it looks like we’re going to be fine.

Wes Moss [00:07:18]:
But what if prices just keep going up and up and up? Well, the answer in my book is through income investing, which is what today’s topic is all about. There’s very few antidotes to inflation. They are real estate. These are properties that can inflate over time. And then there’s income investing, which is what I want to talk about today. If it’s on the mind of Kathy and Charles, it’s on all of our minds, and it’s something I want to address today. Now, before I describe what income investing is all about, I think it’s important to acknowledge that there is no perfect or right way for anybody to invest. There are so many different ways to approach investing.

Wes Moss [00:08:00]:
You can be a cryptocurrency investor. Again, not, not my speed, but it’s worked for millions of people. You can be a bond investor because you don’t like the risk of the stock market and you like the security of steady interest and then maturity schedules. When it comes to bonds, you can be a all growth oriented, no dividend whatsoever stock investor, because these are the companies that are growing the fastest. And if I need money in the future, I’ll just sell a chunk of the companies that have been growing. There’s small cap investing, sector investing, global macro investing, international, small cap international value investing, merger arbitrage strategies. Long, short. The list is almost endless of different styles around how you feel comfortable investing, and many of them work really well over time.

Wes Moss [00:08:57]:
So to approach investing in this way, from an income producing perspective, is not the only way. It’s the way I see investing, which, for as much as we talk about the science of investing and the numbers and the mathematic, theres also an art to investing. And perhaps that side of the art, which, again, weve talked about here on retire sooner, is the emotional side of making sure that you feel comfortable with how youre approaching the investment part of your retirement planning. Thats my first caveat here, is that just because I love this way of investing, this is how we do it, doesnt mean its the only way to skin the cap. By the way, Mallard just gave me two thumbs down because I said that. But it is, there are a lot of great ways to approach this. I want to explain today why I like income investing and how, if you’re thinking about being an income investor, how you’d really approach this. So the big picture here is thinking around, think of the investment pie chart that is your 401k or your investment account, and think about every single sliver or piece of that piece having some sort of asset, whether it’s a stock or a bond or the real estate sector or energy pipeline companies or closed end funds or a variety of different fixed income instruments, all of them having some residual income that continues to come in on a predictable basis into the overall pie.

Wes Moss [00:10:26]:
That could mean dividends that come from stocks, interest that comes from a variety of bonds, and then distributions that come from all these other areas, like publicly traded real estate, energy pipeline companies, closed end funds. And if you put all that together, you have this combination of a variety of different cash flows. In addition to that, the assets that you’re holding in that pie chart should also grow over time. So the formula that we’re all after here is total return and total return. That formula is pretty simple. Tr total return equals growth plus income. The growth piece is really about appreciation. This is a tough one to control, because to some extent, we’re at the mercy of the tide of the market.

Wes Moss [00:11:16]:
If markets are cratering across the board, it’s difficult to get appreciation, at least in that given period of time. Over time, though, again, we believe that even though markets do fall and do correct, they eventually come back and make new highs, provided we’re invested in a variety of companies that are continuing to expand and grow. But the important piece to remember about the growth piece of that total return equation, it’s not overly reliable in the short or even the intermediate term. Again, long term, yes, we should get growth from markets and good companies. But in any given week, month, year, overall market returns are impacted by all of these outside variables. Politics, pandemics, elections, world events, natural disasters, and the list is almost endless. However, the income piece of the equation, and this is why income investing, can check several of these boxes. Both the science or the math of investing and the art, which is making sure you feel comfortable with it, is that income should be highly predictable.

Wes Moss [00:12:24]:
Not perfectly predictable. But if you have a grouping of ten or 20 or 30 different ETF’s or bonds or companies, then collectively the dividends that get produced and the interest that gets produced and the distributions that get produced should be very reliable in any given month, quarter, or year, long before you retired. And you may be thinking, well, I’m only 20 or 30. I don’t need income right now. But just because you don’t need the income right now doesn’t mean your portfolio doesn’t need the income. Because if you have this steady faucet of cash flow coming back into your overall portfolio, and you don’t need to spend it like you would if you were actually in retirement, you get to reinvest it. And reinvesting those dividends and all that income actually turbocharges your overall returns over time. Then, when you actually do stop completely working, which again here on the retire sooner podcast is on your mind, then those same dividends and interest and distributions, all that cash flow that was being reinvested and reinvested when you were younger and accumulating, now becomes a steady paycheck when you’re no longer working.

Wes Moss [00:13:45]:
So I like income investing in both of the phases of our investment life, the accumulation phase and the distribution phase.

Wes Moss [00:13:53]:
Back in 2021, when we first did this income investing podcast, the overall stock market was on track for a record year of dividends or dividend payouts. This is, again, cash coming from companies directly to shareholders. And that year was a record. And dividend payouts were north of $500 billion. For the S and P 500, that’s also a half a trillion dollars in dividend payouts. Here we are in 2024, and the number for this year is expected to be almost $590 billion. So up $90 billion over the last couple of years. If you’ve ever done a Jane Fonda workout, or if you remember as a kid, Rocky running the steps, and if Michael Keaton is still Mister mom to you, then guess what? It’s officially time to do some retirement planning.

Wes Moss [00:14:47]:
It’s Wes Moss from money matters. Weren’t those the good old days?

Wes Moss [00:14:51]:
Well, with a little bit of retirement.

Wes Moss [00:14:53]:
Planning, there are plenty of good days ahead. Schedule an appointment with our team today@yourwealth.com. dot that’s your yourwealth.com dot.

Wes Moss [00:15:05]:
Now, income investing is different than pure growth investing if we’re just growth, growth, growth. That strategy focuses on buying shares of companies that devote every single bit of all their resources and their expansion, every bit of their resources to expansion at all cost. They’re not interested in their profits as much as they are growth, so they may make a dollar per share and they want to reinvest the entire thing back into even faster growth. Dividends are going to come from typically slightly more or much more mature companies that are in maybe a slightly slower growth phase that are focusing on maximizing their profits. And dividends are a way for them to share those profits with investors if you’re a growth growth investor. And again, this is one of these other strategies that can very much work well over time. The equation of the tr, or total return, just equals g. It’s not a g plus I because there’s no income.

Wes Moss [00:16:09]:
In order to generate income or have money to actually spend growth investors have to eventually sell shares in order to convert it to cash to pay the bills. Income investing approaches the market, or investing from a different perspective, stock, dividends, bond interest, and then cold, hard cash. In fact, let’s try to simplify income and investing in general. And in some cases, I’ll actually call this multi asset class income investing, meaning that we’ve got lots of different asset classes, but each one of those asset classes is responsible for pulling some of their weight when it comes to producing income. And I think the simplest way to think about this is through visualizing income investing in four very separate buckets that all work together. Here are the buckets, growth bucket, income bucket, alternative bucket, and cash bucket. And these are the four that work together to accomplish that equation that we’re all after. Total return equals growth plus income.

Wes Moss [00:17:18]:
So let’s start with the growth bucket, and we talk a lot about this one here on retire sooner, because I think this is perhaps the most widely held and understood part of income investing and also takes up the majority, typically, of your overall investment pie. Now, this is going to be different for everyone, but if we’re going by some of the really important parameters for, let’s say, making the 4% plus rule work, which is an enormously important piece of the retirement timeline planning, when you get to retirement, it calls for anywhere from at least 50% to 75% in stocks. So for most investors, not all. That’s the range that we’d be looking for. If you’re younger and still just in accumulation phase, you can certainly be much higher than that 70, 80, 90, or 100% in equities. But as an income investor, this is going to be a piece of the overall pie, not the entire piece of. Not the entire pie. We just mentioned growth, growth companies that don’t have any interest in paying dividends.

Wes Moss [00:18:26]:
So what are these dividend paying sectors? What do they look like? Well, there’s five categories where you see a tremendous amount of focus on paying out dividends. It’s the healthcare sector, utilities, probably most well known for their dividends, telecommunications, financials, meaning banks and insurance companies, and then consumer staple companies. What’s really changed over my 25 year career is that technology companies 20 some years ago were still so new that they were in that hyper growth mode and they weren’t as mature, and none of them paid any dividends or it was very rare to get a dividend out of a technology company. However, in the world that we live in today, because technology companies are so essential to our economy, they’ve become mature and we see some technology companies actually paying out huge amounts in dividends to shareholders. So it’s not just a world where utilities and healthcare and banks pay out dividends. Today, that list includes technology companies as well. How much do these companies typically pay out? Well, to be considered, at least in my book, a dividend paying stock, it needs to be in the two to 5% range. If you would have asked me that five years ago, I would have said three to 6% range.

Wes Moss [00:19:45]:
But because interest rates are so low, it’s brought down the overall yield for almost all assets. So I’m a little bit more forgiving on calling a stock a dividend stock when the ten year treasury yield is still very close to an all time historic low. In fact, we’re going to get to that in a minute. I want to talk about the number of individual companies that actually pay more just in dividend yield than the tenured government treasury. Now, this growth bucket can also include some sectors that may not be paying a ton out in dividends, particularly if you’re younger and you’re still accumulation and you really don’t need income and you maybe have a higher risk tolerance and you don’t necessarily need a, a steady stream of income to give you peace of mind then that growth bucket, even though I’d like to see mostly that full of dividend paying companies, can, of course, hold some companies that are super fast growing and are reinvesting all their profits to grow even faster, and at present still aren’t paying a dividend just yet. Think of the growth bucket as your overall percentage that are allocated to stocks. Next up, the income bucket, also known as the bond bucket. When I say bonds, I mean a variety of bonds, various bonds, because there’s all types.

Wes Moss [00:21:12]:
In fact, the bond market and the amount of bonds outstanding actually far exceeds the stock market. It just gets a lot less press. But within the bond market, we have treasury bonds, municipal bonds, corporate bonds, high yield bonds, international bonds, and floating rate bonds. And they range from ultra safe, like a US treasury bond, as far as the credit or ability to continue to pay interest and then mature to very risky bonds called high yield bonds. And high yield bonds is kind of a newer name, really just a rebranding campaign from what used to be called junk bonds. High yield sounds better than junk. And of course, those yields vary accordingly. In fact, on money matters, I remember many years ago, I used to do a yield ladder, and I used to talk about.

Wes Moss [00:22:06]:
In fact, I’ll talk about it now. The different yields as we move up.

Wes Moss [00:22:10]:
Rungs of the ladder.

Wes Moss [00:22:11]:
And it used to be 4% at the bottom rung all the way up to eight or 9% for the junk bond or high yield rung. I think of that ladder today, and I immediately picture Chevy Chase in Christmas vacation, hanging up his Christmas lights, not paying attention, and immediately slides down ten rungs of the ladder immediately. That’s what the yield ladder looks like today. Because what used to be four at the bottom rung up to nine is now more like one on the bottom rung or almost zero at the bottom rung up to about five. It’s a very different bond world today than we lived in five and ten years ago. And with those different levels of interest rate per year. Treasury bond paying 1% a year, corporate bond paying two or 3% a year, junk bond paying four to 6% per year. We have varying degrees of risk.

Wes Moss [00:23:09]:
Just like the lower your credit score is, the higher your interest rate is on your credit card. Same thing for companies. So a company with a rough balance sheet that’s borrowed so much money that everything has to go really right for them to be able to pay the interest on their debt, and then when it comes due, actually pay the full amount or the full maturity amount of that debt. In order for investors to even take on that risk, they’ve got to be compensated more. Hence the high yield. Maybe just a quick refresher on bonds. Bonds are just ious from a company or government, a soda company wants to build a new soda pop plant, and it’s going to cost them $10 million to do so. So they issue $10 million worth of bonds.

Wes Moss [00:23:53]:
Investors buy that $10 million worth of bonds, they say, we’re going to pay you back the full amount in five years. That’s the maturity of the term on the bond. We’re going to give you 5% per year. And the soda company gets the $10 million today. And investors get paid their 5% every single year for five years.

Wes Moss [00:24:10]:
And at the end of the term.

Wes Moss [00:24:11]:
They get their full principle back again. An IOU from a company or a municipal bond that would come from a local government or a government bond that would come from the us government or some other country. And the way the yield ladder works today, treasuries are at the bottom as we speak. The ten year treasury yield is around one and a half percent. The one to three year treasury yield is well below 1%. Moving up on the ladder, corporate bonds are in the two to 3% range. That’s interest per year. And the junk bonds are in the four, five, and 6% range, depending on the credit of a given company.

Wes Moss [00:24:57]:
Again, lower credit, higher interest rate per year. So that’s what the yield ladder looks like today. That’s what the income bucket looks like today. We’ve talked about here on retire sooner how to rethink that portion of your portfolio. Episode 55 rethinking your balanced portfolio allocation. If you haven’t listened to that. We spend a lot of time talking about the interest rate environment and what to do with bonds. Next up on the docket, the alternative bucket.

Wes Moss [00:25:30]:
This is where we see assets that aren’t necessarily stocks or bonds. They’re somewhere in between. A couple of examples. Real estate investment trusts are reits. Those are publicly traded real estate companies. They probably own reits, might own buildings or data centers, and they pass through their clients rent to you as a shareholder. Master limited partnerships are MLP is. These are typically energy pipeline companies that charge a certain amount to move fossil fuels through their pipes.

Wes Moss [00:26:05]:
They pass a portion of the toll that they collect or that income onto shareholders as distributions. Preferred stocks. These are long term, almost perpetual debt instruments that get issued by companies like banks and utility companies. Closed end funds, another category, which are baskets of really either stocks or bonds that can also use leverage to increase the amount that they pay out to shareholders. And again, these are called distributions, not dividends. Most of the categories in this alternative bucket are closer to the risk of stocks rather than bonds. So we expect higher yields from this group. And you can actually use this bucket as almost a portfolio yield booster, because this alternative investment group typically ranges from the 3% per year income range all the way up to eight or even 9%, again, depending on the risk.

Wes Moss [00:27:06]:
If you’re younger and you don’t need any actual income at all, I can see you being lighter on this particular bucket. When you get into retirement and you really need current income, this is perhaps an area to expand on.

Wes Moss [00:27:21]:
So that’s stocks, stock, dividends, and bonds. What about cash? Good old fashioned money market safety. Safety assets back in 2021, when we originally talked about the cash part of income investing, the Federal Reserve target rate was at 0% zero, and consequently, cash and money markets and almost everything in that safety zone were essentially paying 0% interest as well. But every time the Fed raised interest rates over the last several years, and they did this eleven times, those money market rates went up and up and up and up, and peaked recently at over 5%, a 5% per annum interest rates. Now, even with the recent Fed rate cut by a half a percent, money market rates are still hovering around that 5% level, 4.84.9 in many cases, but those rates will very likely continue to drift lower if and when there are even more fed rate cuts. However, cash is still a very valuable asset, of course, for safety purposes, accessibility, liquidity purposes. But even if rates go down to three or 4%, that’s still significant on this safety portion of an overall investment pie chart. So what’s the bottom line here? Income investing today is just as important here in 2024 as it was when we first started talking about it on the retire sooner podcast way back in 2021.

Wes Moss [00:29:09]:
The basic idea, generating steady income through dividends and interest and other sources. That hasn’t changed much at all. Now, the interest rates on different parts of the market, dividend rates, bond yields, yields on cash, again, much higher today as we sit here and do this episode than back in 2021. And I think that’s a good thing, even though the Federal Reserve has started to lower rates and the philosophy, or the strategy, whatever we want to call it, multi asset class income investing, or just to keep it simple, income investing. Investing in lots of different areas, a variety of stocks for dividends, a variety of bonds for interest, cash that pays interest, and then alternative income areas like energy pipeline companies, real estate investment trusts, et cetera. Put that all together and you have a portfolio. You have an overall portfolio. Cash flow.

Wes Moss [00:30:09]:
Although that cash flow isn’t guaranteed, nothing is when it comes to investing. When it’s coming from a highly diversified place, it takes a lot to push that income level down, particularly because dividend paying stocks, particularly dividend growing companies, really focus on increasing dividend payouts and not lowering them over time. I think that this strategy, and there’s lots of other ways to invest and philosophies around investment. But I still love how income investing helps retirees maintain their purchasing power through rising dividends and distributions and as a way to combat inflation. The whole mix does that. And even though the equity markets and fixed income markets go up and down and up and down over time, the reasons for using income investing today are the same as they were in 2021, in 2019, in 2005 and 1995 to keep your cash flow strong and rising throughout retirement.

Wes Moss [00:31:24]:
So I know income investing is a lot to think about. This is something that our team of over 20 folks on our investment committee think about it every day. So if you’d like help with income investing and maybe either tuning up your own investment income engine or maybe transitioning to income investing, we’re here to help. We’d love to talk to you about it, and you can find our team through wesmoss.com dot. We literally do this every single day and we’d be happy to help.

Mitch Albom [00:31:55]:
Hey y’all, this is Mallory with the retire sooner team. Please be sure to rate and subscribe to this podcast and share it with a friend. If you have any questions, you can find us@wesmoss.com dot. That’s wesmoss.com. you can also follow us on Instagram and YouTube. You’ll find us under the handle retire sooner podcast. And now for our show’s disclosure. This information is provided to you as a resource for informational purposes only and is not to be viewed as investment advice or recommendations.

Mitch Albom [00:32:23]:
Investing involves risk, including the possible loss of principal. There is no guaranteed offer that investment return, yield or performance will be achieved. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions for stocks paying dividends. Dividends are not guaranteed and can increase, decrease, or be eliminated without notice. Fixed income securities involve interest rate, credit inflation and reinvestment risks and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Past performance is not indicative of future results. When considering any investment vehicle, this information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors.

Mitch Albom [00:33:07]:
Investment decisions should not be based solely on information contained here. This information is not intended to and should not form a primary basis for any investment decision that you may make. Always consult your own legal, tax or investment advisor before making any investment tax, estate or financial planning considerations or decisions. The information contained here is strictly an opinion and it is not known whether the strategies will be successful. The views and opinions expressed are for educational purposes only as of the date of production and may change without notice at any time based on numerous factors such as market and other conditions.