By Michael Joseph, CFA
Rising prices are becoming a growing concern for income investors.
For the third straight month, consumer prices accelerated higher. The latest Consumer Price Index (CPI) report showed inflation reached 4.2% year over year in May, its highest level in three years, driven largely by a sharp increase in energy costs.
Whether inflation continues higher, moderates, or moves sideways from here is impossible to know. But as the portfolio manager responsible for the Income strategy at SAM, I believe the lesson is clear: generating income is only half of the equation. The more difficult challenge is building an income stream that can maintain its purchasing power over time.
Inflation is a tax nobody votes for, but every investor pays. It does not show up as a loss on a brokerage statement. Instead, it quietly reduces what your income can buy over time.
A retiree generating $100,000 of annual portfolio income may feel financially secure today. But if the cost of travel, healthcare, insurance, housing, and everyday expenses continues to rise while that income remains unchanged, their standard of living gradually declines.
The danger is that this erosion can be easy to overlook. Many investors focus on the size of the income they receive today, but the more important question is what that income will be worth five, ten, or twenty years from now. Even relatively modest inflation can have a meaningful impact on purchasing power when compounded over long periods.
This is why I believe one of the biggest mistakes income investors make is reaching for the highest yield available. A double-digit yield may appear attractive on a brokerage statement, but investors must ask more important questions: Is that income sustainable? Is the underlying business generating enough cash flow to support it? Can that income grow over time?
Sometimes, the highest yields can be a warning sign rather than an opportunity. The market may be signaling concern that a company’s cash flows are deteriorating or that the distribution may eventually be reduced.
When evaluating income investments, I look for characteristics that may help businesses preserve and grow cash flows through different economic environments. Some have contractual protections against inflation. Others possess pricing power, benefit from higher commodity prices, or provide essential services that consumers are unlikely to abandon. Here are four characteristics I believe can help make an income portfolio more resilient.
1. Contractual Inflation Protection
Some businesses have built-in protection against inflation because their contracts allow cash flows to increase as prices rise.
Casino REITs provide a compelling example. Companies such as VICI Properties own some of the most recognizable gaming properties in the country and lease them to operators under long-term agreements that may include CPI-linked or fixed annual rent escalators. The significant capital invested in these properties, combined with their established brands and strategic locations, creates substantial switching costs for tenants and strong incentives to continue making lease payments.
For income investors, these characteristics can provide an attractive combination of current income, contractual growth, and exposure to valuable real estate assets.
2. Pricing Power and Growing Income
Another powerful defense against inflation is owning businesses that can pass rising costs on to consumers.
Ubiquitous consumer brands such as Coca-Cola and tobacco companies such as Philip Morris demonstrate this concept. These businesses have built strong customer relationships and brands that provide meaningful pricing power. A modest increase in the price of a beverage or nicotine product may have limited impact on consumer behavior, helping protect profitability even as costs rise.
In the case of some tobacco companies, the growth of smoke-free and next-generation products has provided an additional avenue for future growth.
For income investors, this combination of pricing power, durable cash flows, and growth opportunities can translate into a greater ability to maintain and increase shareholder distributions over time.
“Sometimes, the highest yields can be a warning sign rather than an opportunity.”
3. Commodity-Linked Income Streams
The recent acceleration in inflation provides a timely example. Higher energy prices have created challenges for consumers, but energy producers may benefit from stronger commodity prices and increased cash generation. Integrated energy companies such as Shell can provide exposure to these dynamics while also returning meaningful amounts of capital to shareholders through dividends and share repurchases.
Precious metals can also play a role in an inflation-resistant income portfolio. While gold itself does not generate income, investors can gain exposure through businesses that do. Dividend-paying gold miners can provide income while benefiting from higher gold prices, while royalty companies can offer exposure to precious metal production without taking on the same operational risks associated with owning and operating mines.
4. Essential Services and Defensive Cash Flows
Not every inflation-resistant investment needs to directly benefit from rising prices. Some simply provide products and services that consumers are unlikely to eliminate from their budgets.
A household facing financial pressure may postpone vacations or reduce discretionary purchases, but it is far less likely to disconnect its wireless service or stop paying its electric bill.
Companies in industries such as telecommunications and regulated utilities often benefit from recurring demand, stable cash flows, and attractive income characteristics. In certain cases, regulatory structures may also allow utilities to recover higher costs over time.
The Importance of Staying Flexible
One of the greatest mistakes investors can make is assuming that the same income strategy will work in every economic environment.
The opportunities available to income investors constantly evolve. A decade of near-zero interest rates created one set of opportunities. The inflation shock of 2022 created another. Today’s environment of rising inflation, elevated interest rates, and changing valuations may require a different approach.
That is why I believe successful income investing requires flexibility. Some periods may favor real assets and commodity-linked businesses. Others may favor dividend growers, fixed-income securities, or different sources of yield.
At SAM, our Income strategy is built around this philosophy. We seek to generate reliable income by looking beyond traditional income investments and constructing a diversified portfolio of income streams with different drivers of return. Our goal is not only to generate income today, but also to help investors preserve purchasing power and maintain long-term financial independence.
Investors interested in learning more about the principles behind our approach can visit the SAM Income strategy page.
About Michael Joseph
Michael Joseph, CFA is a Portfolio Manager and Deputy Chief Investment Officer at SAM, a Registered Investment Advisor with the United States Securities and Exchange Commission (File No. 801-107061). He sources investment opportunities and conducts ongoing due diligence across SAM’s portfolios.
Prior to joining SAM in 2017, Michael worked with high-net-worth private clients for the largest independent wealth management firm in the United States. He also served as a senior analyst for one of the nation’s largest investment-grade bond managers.
Continue Reading
This article is featured in Modern American Advisor’s Torches of Freedom Market & Investments Strategy section, where portfolio managers, economists, and investment professionals examine the forces shaping markets, portfolio construction, retirement income, and long-term wealth creation. Explore more investment insights and market analysis from leading voices across the industry.
