Steven Bavaria Takes Investors Inside The Income Factory

Summary

• Steven Bavaria discusses his investing strategy, focusing on generating income through high-yield assets like closed-end funds and credit markets.
• He emphasizes the importance of sticking with a strategy that aligns with one’s risk tolerance and long-term goals, whether it’s traditional equity investing or an income factory approach.
• Bavaria recommends considering credit investments, like BDCs and CLO funds, as a favourable option in the current economic and political climate.

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Steven Bavaria takes us inside the Income Factory

Transcript

Rena Sherbill: Steven Bavaria, really nice to have you on one of our podcasts. Really nice to have you on Seeking Alpha. It’s been a long time coming. Appreciate you coming on the show.

Steven Bavaria: It’s a pleasure. Thank you.

RS: It’s a pleasure to have you. Like I said, you’ve been writing on Seeking Alpha for a long time. So, good to have you on finally. You now run an investing group called Inside the Income Factory.

I’d love it if we got started with how you’re approaching the markets. You’ve also written a book about it. So if you could synthesize your strategy and how you approach investing, I think, that’s a nice place to start.

SB: Sure. I guess we could start with the name of the book, The Income Factory and the service Inside the Income Factory. I started out investing like most other people, trying to make an equity return of 8%, 9%, 10%, which has been the average for the last 100 years.

And I realized over time, and this was 12, 15 years ago, that that meant you collect a dividend of 1% or 2% per annum. That would be the typical S&P 500 yield, 1% or 2%.

And you’d be counting on capital gains on average of another 7% or 8% every year. Now not always each year, but on average, every year, to get your 8%, 9%, 10% return. And that’s kind of tricky and angst-ridden for many investors because some years you’re not going to be getting it. You might even be losing money on paper. So you’d only be getting your 1% or 2%.

And since I spent my life in the credit markets as a banker and working for Standard & Poor’s and introducing ratings to the whole bank loan business, I realized that you can make interest rates in the high-yield credit market of 7%, 8%, 9%, 10% per annum.

And if you can get an interest rate of 8%, 9%, 10% per annum, even if you don’t have any growth, you’ve still got the same total return, that 8%, 9%, 10% return that equity investors are seeking to get. Many are trying to get more, but Nobel Prizes have been written by people showing that the typical person over a lifetime is lucky to make the average of 8% or 9%, 10%.

So anyway, I began to experiment and realized that I could invest in high-yield closed-end funds, all kinds of different assets that pay a steady 8%, 9%, 10%, sometimes more in markets like we’ve been in recently in interest. And if you then just get your principal back, you’ve still got your equity return, which you can compound and reinvest just like any other equity investor.

So I began to do that, and I began to write about it 10 or 12 years ago. And people called me a heretic. I’d have people say, oh no, you have to have growth stocks. You can’t grow your wealth without growth stocks. And I would show that, well, math is math. And if you can earn 8%, 9%, 10% in cash and 0% in capital gains, that’s the same 8%, 9%, 10% return as somebody who makes 8% in capital gains and 0% in cash or any combination in between.

So after a while I was – I had more and more followers who tried this and realized that, hey, from an emotional standpoint, you’re not going to make any more money or less with either approach, traditional index investing or dividend growth investing, or – and what I came to call an income factory approach, where you’re just focusing on the income and trying to make most of your total return in the form of income.

You’re not going to do better or worse than either – with either one, probably, but some people are going to be emotionally able to stick with it.

If you’re getting 8%, 9%, 10% in cash that you’re reinvesting and creating your own growth, as I would put it in a lot of my writings, then even in a down market, when you’re having paper losses or equity investors are having losses, paper or real, depending on whether they sell out or not, you’re still reinvesting and compounding your income if you’re getting it in cash.

And that can make you feel – and that can help you sleep at night, which thousands of people have told me since they sleep a lot better at night, knowing their money’s compounding and reinvesting and compounding through all kinds of markets.

And as I wrote about it more and more, and my shtick, as a writer, is basically taking complicated stuff and writing about it in plain English. I came up with this name, The Income Factory, thinking that Ford Motor, when they build a factory, a week after it’s built, the only people at Ford who worry about what its market value is as a factory are the green eye shade accountants in the back room.

But everyone else at Ford thinks more about how do you – what’s the output of that factory? How do we – and how do we grow the output of that factory on a regular basis? How do we buy more machines for the factory, make it grow as a factory in terms of its output? And I realized, hey, that’s really what I want my portfolio to do if I’m in it for the long term.

I see it as a factory whose job is to grow its income. And if it does that steadily by investing in high-yield assets, even though there’s no capital gain, I just keep on collecting that output, reinvesting it. And then later on, if you do this for enough years, hopefully, then you’ll, at some point, be able to retire.

And here again, having a portfolio that’s an income factory, as I call it, where you’re creating your output, your 8%, 9%, 10% cash output without having to sell any of your capital each year, that’s a real advantage once you become a retiree and want to live on some or all of that output, some of that income.

Because if you’re a typical equity investor collecting 1% or 2% cash each year in dividends and counting on another 7% or 8% in capital gains each year, you’re dependent on selling off some of the capital whether or not you’ve got the gains.

If you need 5% or 6% to live on, say as a retiree, and you’re only getting 2% in cash, then you’re going to have to sell, even when the market’s down, some of your capital to get what you need to – for your retirement income.

With an income factory where you’re getting 7%, 8%, 9%, 10% recently in cash every year regardless of what the price of the factory is doing, regardless of what your portfolios, paper losses or profits are, you’re not going to have to sell any capital. You’re going to get it all in cash regardless of what the market’s doing. So that, in a nutshell, is my income factory philosophy.