MENTION A STOCK

to my 97-year-old (and still shrewd) grandmother, and the first question she'll ask is, "Does it pay a good dividend?" It's only in recent years we've become so obsessed with capital gains. But although income-oriented investing is usually associated with retirees set on preservation of capital, it's actually a strategy employed by professional investors, many of whom will often keep the majority of their assets in cash while focusing on a small number of more risky situations. Investing with an income focus is a portfolio approach we first outlined a few months

.

Yet income remains the Rodney Dangerfield of the investment world, and among many traders, dividends, interest and other income-oriented returns are often dismissed altogether. It's much more adrenaline-pumping to buy XYZ at $50 and sell it at $55 than buy a 10% bond and wait patiently for a year.

The real advantage of hedge funds or other advisers focused on absolute return is that they realize real money is made over time and is made by the effect of compound interest, not capital appreciation.

According to Chicago-based Ibbotson Associates, $1 invested in large company stocks in 1926 grew to $2,279 by the end of 2001. That's an annual growth rate of about 10.7%, and assumes the consistent and regular reinvestment of dividends, which have historically produced a yield of about 4.5%.

But get this: Without reinvesting dividends, $1 would have grown to just $90 over the same 76 years. In other words, the majority of total return from stocks has historically come from income, not capital appreciation. It's not an insignificant point, considering that index funds, which we've been dissing for quite some time, are still boasting some of the lowest dividend yields in history. You might be in it for the "long haul," but you sure aren't being paid to wait.

In our continuing series highlighting some of my favorite current investment opportunities, we'll now focus on income-oriented investing by revisiting three separate strategies highlighted in previous columns.

With the major indexes under water yet again, it's no surprise that many investors are seeking the relative stability of bonds, which are generally less risky than stocks. Stockholders might own a company, but it's the bondholders who get paid first if that company goes bust. By definition, bondholders have a senior claim on a company's assets. Stockholders are usually left holding the bag, which in the case of most corporate blow-ups is most likely empty.

Respectfully, I'd point out that we first made the case for bonds last summer, either four or nine months ahead of my exceedingly capable colleagues, depending on just whom you read. And although the bond market is just as diverse as the stock market, generally speaking, it's a call that has made money, and from my perspective, the party ain't over just yet.

Although most investors will opt for Treasurys, the bonds that interest me most these days aren't those issued by the U.S. government, but by foreign and emerging-market nations. As we pointed out last week, foreign bonds are an ideal way to play a weakening U.S. dollar, and emerging-market bonds offer good risk/reward ratios given their bullish fundamentals and hefty yields. Both remain underowned by U.S. investors despite their strong performance over the last year or so. Templeton Global Government Income Trust, a closed-end mutual fund, is a relatively mild way to pump some nondollar bond exposure into your portfolio.

But bonds aren't the only income-oriented investment you should consider making part of your portfolio. Real-estate investment trusts, known as REITs, continue to be among my favorite investment options right now, despite their incredible performance that continues for a third straight year.

We've been talking about REITs since last summer, when I said they were one of the most promising constituents of the quietly thriving American Stock Exchange Composite Index. A few months later, we highlighted how the sector was showing classic signs of an early bull market mainly a psychology of doubt rather than hope. In recent months, we've talked about REITs as both tools for income and diversification.

Thanks to low mortgage rates (which will continue to fall) and increased liquidity (which will continue to rise), I'm firmly of the belief that REITs remain undervalued at current levels. Even given the sector's strong performance, the dividend yield on equity REITs remains well over 6%, higher than it was in 1998. And according to the National Association of Real Estate Investment Trusts, the spread between REITs and 10-year Treasurys still stands near 2%, roughly double the 11-year average. In other words, on a historical basis, REIT-related income is still cheap.

U.S. Restaurant Properties, Mid-Atlantic Realty Trust and Realty Income Corp. are among the names we've mentioned in previous columns that are poised to benefit from increased consolidation and liquidity.

Meanwhile, what to do with the gobs of cash many investors are sitting on? The most sophisticated might want to begin exploring some nondirection options strategies, including one of my favorites selling puts.

We first talked about "systematic writing" last summer, with the Dow near 10500 and while there's been a heck of a lot of volatility in the interim, not much has changed. As much as we are eagerly awaiting a rush to new all-time highs, the broad market could easily remain mired in a trading range for years to come. Income-oriented options strategies, such as selling puts or hedging with calls, give you the possibility of profit regardless of market direction. Although the strategies' risks are defined, they aren't absent altogether. Obtaining a copy of the CBOE's Characteristics and Risks of Standardized Options is a must.

Jonathan Hoenig is portfolio manager at Capitalistpig Asset Management, a Chicago-based hedge fund. At the time of writing, Hoenig's fund held positions in many of the securities mentioned in this article.