Income investors face a continual trade-off between risk and reward. At asset class level they can hold cash or government bonds to generate a relatively reliable, albeit historically lacklustre income return. Or they can purchase assets such as equities that offer the prospect of inflation-beating dividend growth in return for a higher chance of income volatility.
There are also wildly differing risk/reward income opportunities within the stock market. Some companies, such as utilities and tobacco stocks, have historically offered stable income returns. Others, in contrast, have produced wild variations in dividend payouts that, while proving to be relatively high over the long run, have fallen heavily during periods of temporarily weak economic growth.

An improving global economic outlook
Industries such as energy and basic materials, which include oil & gas and mining companies, respectively, are often among the most volatile income stocks due to their financial performance being heavily reliant on highly changeable commodity prices.

While they have experienced an uncertain period over recent years amid a weak global economic outlook that could persist in the short run, their relatively attractive yields, stable financial positions and improving operating prospects mean they could be worthwhile income investments on a long-term view.
After all, the world economy’s period of rampant inflation, rapidly rising interest rates and weak economic growth is now in its latter stages. While sticky inflation means the exact timing of interest rate cuts in the US, Europe and the UK may be subject to change, significantly looser monetary policies are ultimately set to be introduced over the coming years. In the US, for example, the Federal Reserve’s latest forecasts show that it expects a gradual decline in interest rates over the next two years so that they stand at around 3.1% in 2026.

Lower interest rates should, all things being equal, have a positive impact on global economic activity levels. This should raise demand for, and the prices of, a wide range of commodities and provide improved operating conditions for oil & gas and mining companies.

Stronger financial performance is likely to prompt increased dividend payments, since in many cases shareholder payouts represent a pre-determined percentage of overall profits, as well as capital growth that further enhances total returns for income-seeking investors.

Favourable risk/reward opportunities
While energy and basic materials companies have experienced a period of elevated uncertainty, in many cases their financial positions remain sound. While a solid balance sheet does not equate to robust dividend payments, since shareholder payouts are generally dependent on profits, it means that the risk of permanent capital loss is relatively low.

A solid balance sheet should also allow for any growth in profitability to be passed on to investors in the form of higher dividends. Indeed, a firm that enjoys a sound financial position will not necessarily need to use a large proportion of profits to reduce net debt or shore up its balance sheet.
In any case, the heightened volatility of profits and dividends among oil & gas and mining stocks appear to be factored into their yields. Since they are generally higher at present than those of companies operating in more stable industries, as well as the wider stock market, they provide a margin of safety for income investors in case profits temporarily fall and dividends are cut.

Relatively high yields also compensate long-term investors for the prospect of delays to falling inflation, declining interest rates and higher activity levels for the world economy.

Of course, high yields and solid financial positions do not eradicate the inherent income volatility of oil & gas and mining stocks. Investors who require a stable income stream will therefore almost inevitably find them undesirable. But for investors who can take a long-term view and look beyond heightened dividend volatility in the near term, buying a range of financially sound resources stocks with attractive yields could mean obtaining a generous income return as the world economy’s outlook gradually improves.