A carefully crafted investment portfolio can achieve multiple financial goals. For example, in addition to building savings for retirement, an investment portfolio can also be used to generate ongoing supplemental income that can be valuable at any point in life, including retirement and long before.
Investing for income often involves a combination of assets like dividend stocks, bonds, mutual funds and real estate, but the specific approach will depend on each person's unique needs and goals.
What is Income Investing?
Investing for income involves generating a reliable, passive stream of income or cash flow through your investment choices. This goal can be achieved in a number of ways, depending on your financial objectives and risk tolerance.
While income investing is often seen as a way to generate retirement income, that's not necessarily the case. Income investing can also be used to establish a valuable income stream that you can rely on for the rest of your life. In fact, a recent survey by investment platform Magnifi found that 49% of Americans invest to earn additional income, more than those who invest for retirement income (42%).
“Income investing is popular in retirement, providing a stream of income after you stop working, but can also be a passive source of income before you retire,” says John Clough, general manager at Magnifi. “There are only so many hours in a day, but income investing allows your money to earn money for you with relatively little time and effort.”
What are your main types of investment income?
There are many different options for investing. Some of the most common options include dividend-paying stocks, bonds, money market mutual funds, real estate, etc. Each option has its own advantages and disadvantages to consider, including different risk levels and the level of investment required to generate a return.
Types of assets that generate revenue
Dividend stocks
When you own stocks, you become a shareholder in the company, and when the company generates profits, you can choose to reinvest that money in the business or distribute the profits to shareholders in the form of dividends.
“Dividends are paid when a company has excess profits and wants to reward shareholders for their investment,” says Kyle McBrien, a certified financial planner at investment platform Betterment.
However, not all companies pay dividends to shareholders, so if you're focused on investing for income, it's important to choose stocks that 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 or municipal bonds, bonds issued by companies, and exchange-traded funds (ETFs) that contain multiple bonds.
Bonds are issued by organizations such as governments and companies when they need to raise funds. To do this, the government or company sells bonds to investors as a form of debt and promises to repay the investors with interest within a certain period of time. When investors buy bonds, they buy someone else's debt and earn income from the interest paid by the borrower.
“Governments and hospitals sometimes issue bonds to raise funds to complete a particular project. The bond holder is the lender, and the borrower promises to repay the bond with interest at a set time in the future,” Clough says.
Bonds are sometimes called fixed-income investments, in reference to the payment schedule investors receive. “They're fixed income because you know in advance when and how much interest you're going to get,” Clough says.
Bonds, especially government bonds, are considered a lower risk investment compared to stocks and can help reduce volatility by diversifying your portfolio. Corporate bonds are slightly riskier than government bonds, but they also offer higher returns.
Money Market Accounts
Money market accounts are another way to generate a modest income in the form of interest or dividends. These accounts are similar to checking accounts in that they often offer debit card access and check-writing capabilities. However, money market accounts usually earn monthly interest, whereas many checking accounts do not.
“Some people use money market funds to maintain liquidity while generating moderate returns, usually with low risk, and to ensure that investable cash doesn't sit idle,” Clough says. “Money market accounts are also a way to diversify your portfolio and provide easy access to your cash.”
Money market accounts, which often require you to maintain a minimum balance, can be an important part of your overall financial portfolio, although they don't provide as much income compared to other assets and investments.
real estate
Some investors incorporate real estate into their income-generating strategies. But this doesn't necessarily mean buying property yourself and becoming a landlord. Real estate income can also be earned through investments called real estate investment trusts (REITs). These funds allow investors to buy stocks that pay dividends, much like dividend stocks.
A real estate limited liability partnership (RELP) is another option, in which you combine your funds with other investors to develop or purchase real estate.
The pros and cons of income investing
Investing for income is a great way to establish a passive income stream, but there are some risks to keep in mind.
Strong Points
- Supplemental income sources. The most obvious benefit of investing for income is that it creates a continuing stream of money that you can spend on anything you like. Whether you're preparing for retirement or need extra income to handle unexpected life changes, investment income can be a valuable safety net.
- Growth of potential capital stock. Your investment may also increase in value, resulting in a capital gain. “Capital gains are the profit you make when you sell an investment. If you buy a stock and it increases in value, your capital gain is the difference between the purchase price and the sale price,” Clough says.
Cons
- Fluctuations in income. Dividend and interest payments fluctuate over time, so this income stream can increase or decrease with market changes. “Because dividend payments are tied to a company's profits, their frequency and amount will naturally fluctuate. Similarly, bond interest payments fluctuate as the Fed adjusts the federal funds rate,” McBrien said.
- Risks associated with investing. With any type of investment, whether you put your money into stocks, bonds, or other similar assets, you are taking on risk. “When you're trying to build a portfolio that will generate strong returns, it's important to consider the overall risk of your portfolio. For example, investing 100% in dividend stocks is very different from investing 100% in high-quality bonds. Investors should evaluate their own risk tolerance when considering how much of each to include in their portfolio.”
summary
Investing for income can be an important strategy at any stage of life, and just as importantly, you don't have to choose between a retirement-prepared portfolio and an income-generating portfolio — you can do both at the same time.
“You can have a portfolio that's focused on income and another that's focused on long-term growth and retirement, or you can switch between these strategies when the time is right,” Clough said.