For an aging population eager to bolster current income and enhance the security of investment returns, income-generating investments have never been more critical. But in an era of all-time low interest rates, many traditional income sources are unappealing.

Investors' search for income is increasingly taking them to what may seem, at first blush, an unlikely source-the stock market. There is renewed investor interest in equities-dividend-paying stocks and stock funds, in particular-and in professional guidance in identifying the best opportunities. Delivering essential guidance to clients anxious to tap alternative strategies for generating income is one of today's most meaningful advisory opportunities, a finding demonstrated by a recent national poll we conducted among mass-affluent investors.

 

LOOKING FOR INCOME

In December, in conjunction with market research firm GfK Roper Public Affairs and Corporate Communications, we polled 1,000 investors online with at least $250,000 in investable assets. Eighty- five percent of respondents said that dividend yield is very or somewhat important when evaluating an investment, and nearly half (46%) said generating income from their portfolio is more important today than previously. Asked about the best strategy for generating income right now, a majority (52%) of investors cited dividend-paying stocks, while 19% tabbed interest-paying bonds and 29% said they did not know.

This budding interest in dividend-paying stocks goes hand in hand with a renewed confidence in the market. Sixty-five percent of the investors we talked to believe the stock market will go up over the next 12 months, compared with 50% who said so in August. Forty-eight percent of investors believe it is a good time to invest in the stock market, compared with 35% in August.

 

BOND MARKET CONCERNS

What's driving this renewed interest in stocks and increased focus on income? The personal financial planning considerations of investors nearing retirement certainly play a role, with many increasingly concerned about how to generate relatively secure income streams in retirement. However, concern about bond prices is also a key driver.

While two-thirds of the investors surveyed expect the stock market will end 2011 in positive territory, only one-third believe the bond market will do so. Thirty-six percent of those surveyed believe that bond valuations are stretched and that the bond market is due for a major correction. With memories of the 2008-2009 market meltdown still fresh and with many investment professionals and media commentators wringing their hands over bond prices, it's hardly surprising that investor concern over the bond market is percolating to the surface.

Investors would like your help reallocating into stocks. Twenty-eight percent of the investors surveyed said they would like to take money out of bonds, but "don't know where to put it;" 24% said they didn't really know enough to say whether they should be reducing their exposure to fixed income.

But for many investors the decision to move back into stocks comes with some degree of hesitation. While they are more positive about stocks than six months ago, concerns linger. In our survey, 20% of investors said that they were very hesitant to increase their allocation to stocks and another 39% said they were at least somewhat hesitant.

 

THE PERFECT STORM

When it comes to developing strategies for owning income-generating stocks, and the market generally, many investors are handicapped by misunderstanding-or lack of awareness-of investment fundamentals. But something else is at work-lingering, deep-seated investor uncertainty in the wake of the "big downturn."

The market and economic volatility over the last few years has left a profound and lasting impression. About eight in 10 said the recession is not over yet, and 70% believe a major stock market downturn is likely in the next five years. Not surprisingly, a majority (53%) said events of the last few years have had a lasting impact on how they invest.

In short, investors' improved outlook for the markets is in the context of some changed beliefs. Investors' heads may tell them that the market and economic volatility of 2008-2009 was phenomenal in nature, but their hearts have yet to catch up with that thought. Wary of fixed income but still hesitant about embracing equities all over again, many investors are at a crossroads.

Investors need and want your help. In our survey, 52% (including about two in 10 of those not currently working with an advisor), said they "feel like I need a professional advisor now more than ever." A strong majority of investors with advisors report feeling confident in the professional guidance they receive, following their advisor's advice most or all of the time. In fact, even though investors are generally hesitant to increase their allocations to stocks, 72% of advised investors said it's likely they would do so if their advisors recommended it.

 

ACT ON OPPORTUNITY

While there is keen and growing interest in stock dividends, investors face a steep learning curve. At the most basic level, many investors struggle to understand fully how dividends impact return.

Almost two-thirds (64%) said they had no idea how much of the market's annual return comes from dividends. Among those answering the question, the mean response was a little under 19%. In reality, from 1930 through September 2010, dividends accounted for 44% of the S&P 500's average annual total return.

Clearly, there is a huge and urgent need to address client interest in income generation as well as an opportunity to address some fundamental investing issues. Many advisors already are taking up the challenge.

For example, some are turning their clients' focus on income into a much broader, valuable discussion about core portfolio strategy. According to Jeffrey Ivory, a partner at Stonebridge Financial Partners in Bingham Farms, Mich., there can be tremendous pressure merely to push clients up the risk curve to get a decent yield. "But that becomes an opportunity to refocus my clients on the big picture-building a balanced portfolio that seeks an appropriate level of risk and reward," he says.

Advisors have a clear role to play in helping clients "get real" about the risks as well as the opportunities of income-generating equities. When recommending stocks or stock mutual funds to clients, we often hear from advisors that they take pains to avoid chasing yield. Instead, they look for high-quality companies, or stock funds that invest in those companies that are positioned to continue increasing their dividend. In fact, many times a cut dividend is a criterion for getting rid of a company, and when using dividend stock funds they look for ones that have a similar, disciplined sell strategy.

At the same time, Ivory says dividend reinvestment has an important role to play in clients' accumulation strategies, particularly among those clients who need to play catch up with retirement savings. In fact, Ivory has found that the dividend story resonates with clients on many levels. In addition to generating income and putting more power behind compounding, dividends can also help soften the blow during down markets.

 

GOING FORWARD

Advisors have a major opportunity to help their clients in their search for income while reinforcing some basic investing principles. Here are five tips to help you help clients explore the potential of income-generating equities-and renew their comfort with the equity markets in general.

* Be clear on risks. With clients who rely on the income their investments generate, it's hard not to chase yield. Advisors have a clear role to play in educating their clients about the risks associated with moving higher up the yield curve and in helping clients take steps in their portfolios that align with their risk tolerance. It is important to reiterate that dividends are not guaranteed and equity investments can lose value.

* Diversify with funds. With dividend stock funds, it takes less client assets to diversify appropriately, freeing up money to take advantage of asset allocation. Ivory uses dividend stock funds with almost all of his clients with $1 million or less in assets. "Most of my portfolios that size would not be properly diversified otherwise," he says.

* Ease into it. Dividend stock funds can also be a good option for clients who are wary of getting back into the stock market because, in addition to instant equity diversification, the dividends often provide a cushion beneath the fluctuating fund price.

* Show dividends are not just for current income. For investors who are more focused on growth potential, demonstrate how much reinvesting dividends earned can help boost an overall return and significantly add to the power of compounding.

* Help clients get real. Working with clients who have unreasonable expectations for generating income? If clients are willing to put their nest egg at risk in exchange for higher yields, perhaps it's time to have a frank discussion about future expenses and creating more realistic expectations for retirement.

Today's income landscape is a perfect storm for investors, but a great opportunity for advisors to reaffirm fundamental investment principles while implementing strategies to mitigate the concerns that may be holding clients back. Don't lose this chance both to make an immediate difference and to better position your clients for the long term.

 

Roddy Marino is head of advisory sales for Allianz Global Investors Distributors. To learn more strategies for investing in dividend-paying stocks, go to www.allianzinvestors.com/dividends to download a copy of Dividends: Sharing the Wealth.