The one thing I have been hearing a lot recently is that people are worried – they’re worried about volatility and geopolitical risk, AI leading to job loss, and increasingly erratic behaviour from the U.S. administration. Because of this, many people are keen to build and maintain alternative sources of income. To help with this, we write a monthly column on income investing, including what it is, the difference between growth and income, and whether younger investors need income at all.
With the war in Iran moving into its second month, investors are increasingly worried about risk. Like a friend recently told me, “I’m dealing with enough stress and risk in my day job, now you’re telling me my income investment stream is ALSO risky?” I understand her sentiment, but the fact of the matter is that all stock investing involves risk. The way to deal with it is to arm yourself with knowledge about how it works. This should help you cope, especially when stock markets are volatile.
What Risks Should Income Investors Worry About?
Like we said in our income investing piece, income investing is about generating a steady stream of income by investing in securities that generate income through interest, or rent, or dividends. There are risks with this kind of investing.
Here are some of the important risks with income investing that smart investors should consider:
Interest Rate Risk:
Once every couple of months, the Bank of Canada makes an announcement around interest rates. You can find the schedule here. On these dates, the central bank announces if it will raise, hold, or lower interest rates. When interest rates rise, the market value of existing bonds and fixed-income holdings falls, and vice versa. Income investors should note that whether rates rise, or fall, there will be an impact on your portfolio.
Dividend Cut Risk:
Canadian investors love their dividends. But it is critical to remember that dividends are not forever promises. Companies announce their dividends on a regular basis, but some investors feel that these are a guarantee. They are not. Companies can and do cut dividends, especially in times of recession, or downturns. A suspiciously high yield could mean that a cut might come, or a suspiciously low yield could mean a rise is coming. But there is no way to know for sure, so investors should adjust their expectations.
Liquidity Risk
Many older investors have second homes that they rent out for income. Others invest in GICs, or alternative credit products. While these may generate a higher income, it is important to remember that you are also tying up your liquidity. For example, right now, home prices in Canada are lower than before. So if you need to sell your home for whatever reason, you will almost certainly command a lower price than 5-years ago, when the market was at a peak. To protect yourself, you should make sure that your portfolio has enough liquid holdings to cover several months of needs.
Concentration Risk
The friend I referenced earlier who complained about risk was talking to me about her portfolio when we had the risk conversation. A huge percentage of her portfolio was tied up in Canadian banks, because they are steady dividend payers. While investing in Canadian banks might be relatively less risky than other sub-sectors, diversification is important to have a balanced portfolio by staying invested in only a single sector, you run a concentration risk – if a single event affects the banking sector, your portfolio may experience significant decline. It might be in your best interest to have a portfolio which is diversified across sectors, and geographies.
How to Balance Risk and Reward in Income Portfolios
Now this should not mean that you think everything is only risk and there’s nothing but despair – after all, you do get income as a reward for these risks. All this means is that you should be aware of the risks, take steps where you can to counter the risks, and understand your own risk profile so that you can invest in a way is inline with your risk tolerance, and investment goals. Here are some ways to balance the risk and rewards:
What Does “Safe” Mean? It Depends on You
As discussed, no investment is fool-proof and nothing is guaranteed. There is always some risk involved. Lower risk investments like government- bonds, or GICs with a guaranteed return usually have much lower upsides. If you want to invest only in low-risk investments, especially if you’re much earlier in your investment journey, chances are it will be harder to meet high-priority goals. To counter this, you should know exactly what your risk appetite and risk tolerance is. The two are different – risk appetite is how much risk you want to take, while risk tolerance is how much risk you can actually handle. Here’s analogy to help you understand the difference between having a “appetite” and a “tolerance” for something. The Rogers Centre in Toronto has a Loonie Dogs Night where you get a $1 hot dog on every Tuesday home game of the 2026 season. For the first one, my friend was convinced he could eat 10 hot dogs and even spent $10 on them when we arrived. He managed only 5 before feeling sick,so the rest of us got 5 free hot dogs. The point is, while his appetite was 10 hot dogs, his actual risk tolerance was just 5. Risk works in a similar vein, in that your appetite for risk may be significantly lower than your actual capacity to tolerate risk.
What You Should Do: Know your risk appetite and risk tolerance, and invest accordingly.
Where You Hold Your Investment Matters
I am a big fan of tax-free accounts like the TFSA and tax-deferred accounts like RRSPs. Where you invest your money matters a lot. Here is a short explanation. If you have a choice, it may makes sense to maximize the accounts in which you can pay the least amount of tax, so you can keep a lot of your earnings and income. For instance, all income earned in a TFSA is tax-free. But in an RRSP, it is tax-deferred and paid upon redemption. That said, each has its purpose, so it’s worth thinking about when it makes more sense to one over the other.
What You Should Do: Know where you’d get the most tax advantage and park your investments there.
Diversification: The Only Free Lunch in Investing
There is a quote often attributed to Nobel Laureat Harry Markowitz that says, “Diversification is the only free lunch in investing.” What this means is that if you have a well-diversified portfolio, losses in one area are made up by gains in another. For example, if the tech sector falls, you lose money there, but if at the same time utilities rise, you gain money there.
What You Should Do: Diversify. Diversify. Diversify.
Junk Bonds Are Called That for a Reason
Sometimes, when investors are looking for yield, they just go out and buy the highest yielding securities they can find. Sometimes this could work, but sometimes it could end badly. If a government bond is at 3%, but a corporate bond is at 9%, you should know that the reason for it is that the corporate bond has a much higher risk profile.
What Should I Do: Just like with stocks, know both your risk appetite and risk tolerance for bonds too.
Remember How the Wolf of Wall Street Ends
I enjoyed the Wolf of Wall Street very much. So do many of my friends. But I find as time passes, most people remember the start, but few worry about the end of the movie (Spoiler: Jordan gets arrested.) Most investors, maybe even you, and definitely me, don’t have the time, knowledge, skillset, and control to time the market and ride out every movement. The best thing for most investors to do is invest in a few securities of companies that they understand, and then leave it alone, apart from periodic check ins.
What Should I Do: Automate, simplify, and reduce the urge to check your portfolio daily.
Now you know how to balance risk and reward in income investing. One way for investors to gain income is by buying covered call Exchange Traded Funds (ETFs). Covered Call ETFs aim to generate income for investors through owning a portfolio of stocks and then selling call options on those stocks to help generate income paid to investors. You can find out more about covered calls here. Harvest Portfolios has a wide range of covered call ETFs for investors of all stripes. Harvest income ETFs have paid out over $2.5 Billion in total cash distributions since inception. Our equity portfolios focus on established businesses, leading themes, and secular trends across sectors, combined with an active covered call strategy to provide a dual approach of generating high monthly income and long-term capital growth. Whether you prefer Canadian single stocks, or US, balanced asset allocation funds, or diversified income ones, there’s something for everyone.
Disclaimer
The views and/or opinions expressed above are of a general nature and are for informational purposes only. The contents should not be considered as advice and/or a recommendation to purchase or sell the mentioned securities or used to engage personal investment strategies. Investors should consult their investment advisor before making any investment decision. Commissions, management fees and expenses all may be associated with investing in Harvest Exchange Traded Funds (managed by Harvest Portfolios Group Inc. (the “Funds”). The funds are not guaranteed, their values change frequently and past performance may not be repeated. Please read the relevant prospectus before investing. This communication should not be considered as advice and/or a recommendation to purchase or sell the mentioned securities or used to engage in personal investment strategies. Tax, investment and all other decisions should be made with guidance from a qualified professional.
