A thoughtfully created investment portfolio can accomplish multiple financial goals. In addition to creating a retirement nest egg, for instance, your investment portfolio can also be used to generate an ongoing stream of supplemental income that can be valuable at any point in life—whether during retirement or long before.
Investing for income often involves a mix of assets, including dividend-bearing stocks, bonds, mutual funds, and real estate, though the exact approach will vary based on each person’s unique needs and goals.
What is income investing?
Investing for income involves creating a reliable, passive source of income or cash flow through your investment choices. This goal can be accomplished in several ways depending on your financial objectives and risk tolerance.
“Any time you invest, you’re letting your money work for you, and that’s particularly true with income investing—where the goal is to produce a regular stream of income,” says Jamie Hopkins, managing partner of wealth solutions at Carson Wealth, a financial planning and investment management firm. “To achieve that steady stream of income, investors will build a portfolio with securities and assets like bonds, dividend-paying stocks, and real estate. There is no exact formula to income investing, and there are a lot of ways to add income-generating assets to your portfolio.”
While income investing is often viewed as a way to create income for retirement, that’s not always the case. Income investing is also used to establish a valuable income stream that can be relied upon throughout the course of life. In fact, a recent survey conducted by the investment platform Magnifi found that 49% of Americans invest to earn additional income, which is more than those who invest for retirement (42%).
“Income investing is frequently used in retirement with investments providing an income stream when you stop working, but income investing can also be a passive income stream before retirement,” says Jon Klaff, Magnifi’s general manager. “You have a limited amount of time in the day that you can work, and income investing gets your money to make money for you with relatively low time and effort.”
What are the main types of investment income?
There’s many different options when it comes to investing. Some of the most common options include dividend-paying stocks, bonds, money market mutual funds, and real estate. Each option comes with its own benefits and drawbacks to consider, including varying risk levels and level of investment required to generate income.
Types of income-paying assets
Dividend stocks
When you own a stock, you are a shareholder in a company. And when companies produce revenue, they can choose to put that money back into the business or share the profits with shareholders in the form of dividends.
“Dividends are received when a company has extra earnings and wants to reward shareholders for investing in the company,” says Kyle McBrien, a certified financial planner with the investment platform Betterment.
But not all companies pay dividends to stockholders. So if you’re focused on investing for income, it’s important to select stocks that do offer this benefit.
Bonds
Bonds are another asset that can be used to generate income. There are many different types of bonds including individual government and municipal bonds, corporate-issued bonds, and exchange-traded funds (ETFs) that contain multiple bonds.
Bonds are created when an entity, whether it’s a government or a company, needs to raise money. To do this, the government or company will sell bonds to investors in the form of debt and promise to pay investors back, with interest, over a set period of time. When investors buy bonds, they’re buying someone else’s debt and the income results from the interest payments made by the borrower.
“A government or hospital might issue a bond to raise funds to complete a specific project. As a bond owner, you are the lender, and the borrower is promising to pay you back at a set time in the future with interest payments along the way,” says Klaff.
Bonds are also sometimes dubbed fixed-income investments in reference to the schedule of payments investors receive. “It’s fixed-income because you know ahead of time how much interest you’ll be getting and when,” says Klaff.
Bonds, particularly government bonds, are considered lower-risk investments compared to stocks and can provide diversification in a portfolio to reduce volatility. Corporate bonds are somewhat riskier than government—but they also offer higher returns.
Money market accounts
Money market accounts are another way to generate modest returns in the form of interest or dividends. These accounts are very much like checking accounts in that they may often offer debit card access and check-writing capabilities. However, money market accounts typically offer monthly interest, which many checking accounts do not.
“Some use money market funds to maintain liquidity while generating modest returns, at typically low risk, so that your investable cash never sits dormant,” says Klaff. “Money market accounts are also a way to diversify your portfolio, and your cash is still easily accessible.”
Money market accounts, which often require maintaining a minimum balance, can be an important part of your overall financial portfolio. But they do not generate significant amounts of income compared to other assets and investments.
Real estate
Some investors also include real estate in an income-generating strategy. But this doesn’t necessarily mean buying a property yourself and becoming a landlord. Real estate income can also be achieved through investments known as Real Estate Investment Trusts or REITs. These funds allow investors to buy shares that pay dividends, in much the same way a dividend stock does.
Real Estate Limited Partnerships (RELPs) are another option and involve combining money with other investors in order to develop real estate or make real estate purchases.
Pros and cons of income investing
While investing for income can be a great way to establish a passive stream of money, there are some risks to bear in mind.
Pro: Supplemental source of income. The most obvious benefit of investing for income is generating an ongoing stream of money that can be used for whatever you want. Whether you’re preparing for retirement or need extra income to accommodate for unexpected life changes, investment income can be a valuable safety net.
Pro: Potential capital stock growth. Your investments can also increase in value, generating capital gains.“Capital gains are profits from the sale of your investment. If you buy a stock and it increases in value, the capital gains are the difference between your purchase price and sale price,” says Klaff.
Con: Income fluctuation. Dividends and interest payments are variable over time, which means this income stream can increase or decrease with shifts in the market. “Because dividend payments are tied to company profits, they will naturally fluctuate in frequency and value. Similarly, interest payments on bonds fluctuate as the Fed adjusts the fed funds rate,” said McBrien.
Con: Risks associated with investing. As with any type of investment, you take a risk when putting your money in stocks, bonds, or other similar assets. “If someone is looking to build a strong income-producing portfolio, it’s important to consider the overall risk of your portfolio. For example, investing in 100% dividend paying stocks is vastly different from investing in 100% high-quality bonds. Investors should evaluate their own risk tolerance when considering how much of each to include in their portfolio.
The takeaway
Investing for income can be an important strategy at any phase of life. And equally importantly you don’t have to choose between a portfolio designed to provide for your retirement years and a portfolio designed to generate income. You can do both simultaneously.
“You can have a portfolio focused on income plus a portfolio focused on long-term growth and retirement or even switch between these strategies when the time is right,” said Klaff.
This story was originally featured on Fortune.com
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Source: https://finance.yahoo.com/news/income-investing-strategy-building-portfolio-141400823.html