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Investing in the stock market can be a risky endeavor. But many investors are looking for returns higher than they can find from the safest bets like government bonds. Those who are interested in getting a steady stream of income from their investments while keeping their risk relatively low will want to consider focusing on gaining equity income.

What Is Equity Income?

Equity income is income that investors earn via stock dividends, which is money that companies pay to shareholders out of their net profits to reward them for investing. You can get dividends either by owning shares of stocks or by owning shares of mutual funds or exchange-traded funds (ETFs) that invest in dividend-paying companies.

Equity income is appealing to conservative investors who are focused on generating long-term income. The large, established companies that pay dividends often have an annual target for a dividend payout rate that they incorporate into their financial planning. This means that investors can count on this income, at least more than they can count on other returns from owning stocks.

That being said, it’s important to know that companies do not have a legal obligation to pay dividends; they can reduce or end them whenever they want for any reason. Dividends are likely to shrink if the company’s profits shrink. But the reverse can be true too — a banner year for the company may result in higher dividends.

‘Income’ Stock vs. ‘Growth’ Stock

Stocks that have a record of paying a regular dividend are knowns as “income stocks.”
These stocks contrast to “growth” stocks, which tend to have a higher level of risk and expectation of return.

The companies that pay income stocks tend to be large, well run, and more stable than the larger equity market. An appealing income stock will be one with less volatility than the market as a whole, but with better returns than are available from other income investments, such as U.S. Treasury bonds.

True to its name, a growth stock focuses more on growth than stability; it’s a share in a company that is on track to grow faster than the market but probably will not be paying any dividends to shareholders. These types of companies tend to reinvest their profits into the business to spur more growth, which might mean high returns but also leads to more potential volatility.

What Is an Equity Income Fund?

An equity income fund is a type of mutual fund that focuses investment on a range of dividend-paying stocks. These funds may target their investments in various ways: by a benchmark dividend yield, a geographical focus, or target companies’ credit-ratings.

As with other types of mutual funds, equity income funds give investors the opportunity to diversify, since they are able to buy an interest in multiple companies via purchasing even a single share of the fund. This provides less exposure to risk than buying individual stocks. Since income stocks are already on the lower end of the risk spectrum, buying equity income funds is a particularly good way to reduce risk.

What Are Forward and Trailing Dividend Yields?

An equity stock’s or fund’s dividend yield is the amount of equity income shareholders receive. Each one has a forward dividend yield and trailing dividend yield, which can help investors assess the payout as a fraction of the price.

A forward dividend yield is an estimate of the dividend yield for the current year, derived from available information. The trailing dividend yield is the amount of the dividend payout during the previous year, based on share price.

Benefits of Equity Income Investing

There are several good reasons to invest in equity stocks and funds.

Long-term income
Investors often seek to hold income stocks for the long term. Those who favor these types of investments prioritize capital appreciation and income instead of rapid growth. One way investors can increase their long-term income from equity stocks is through dividend reinvestment, which allows an investor to reinvest dividends in fractional shares of the stock or fund.

Lower risk than growth stocks
Dividend-paying stocks are seen to be generally less risky than stocks that don’t pay dividends. They carry more risk than other common income investments, such as bonds and cash, but they are less risky than other stocks and mutual funds, particularly growth stocks.

Relatively high potential returns
Compared to other income investments like bonds or money market funds, equity income stocks and funds are apt to provide higher returns. While they may not generate the high returns of growth stocks, they will be a more lucrative investment than a cash account.

To provide an idea of returns, these were the top five dividend-paying stocks on the Russell 1000 stock market index as of June 1, 2021:

  • OneMain Holdings Inc. (OMF) (forward dividend yield of 13.06%)
  • Annaly Capital Management Inc. (NLY) (forward dividend yield of 9.69%)
  • AGNC Investment Corp. (AGNC) (forward dividend yield of 8.03%)
  • New Residential Investment Corp. (NRZ) (forward dividend yield of 7.46%)
  • Equitrans Midstream Corp. (ETRN) (forward dividend yield of 7.35%)

FAQs about Equity Investing

Q: Who should use an equity income strategy?
A: Investors with relatively long-term time horizons for their investing should consider this strategy. Those who need cash-generating investments for major needs like funding retirement can particularly benefit from receiving dividends.

Q: Which kind of stocks are the best fit for an equity income portfolio?
A: An equity income portfolio should focus on domestic, large-cap, and high-profile stocks — companies like Apple, Microsoft, Johnson & Johnson, and Verizon, for example. Add in some mid-size companies and international large cap stocks and you’ll end up with a diversified mix. Try to avoid stocks from companies that have cut their dividend in the past.

Q: What would make you want to sell a stock?
A: Investors should look for dividend yields that are as high as possible. It is a good idea to sell when the price of a dividend stock appreciates faster than the growth of the dividend, meaning that the dividend effectively yields less over time. It’s also smart to sell stocks of companies that are paying out a large percentage of earnings in dividends.

4 Ideas to Remember About Equity Income

  • Equity income is a good way of securing long-term income, and reinvesting dividends can make a big difference in your overall returns over time.
  • Equity income investing focuses on achieving relatively low risk and relatively high return — a good middle ground between risky growth stocks and extremely safe but less lucrative income investments like bonds.
  • Income stocks, which pay dividends, are usually shares of large, established companies.
  • Investing in equity funds allows investors to diversify their holdings while keeping risk relatively low.

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The information and data are as of the July 13, 2021 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi. 

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