Building wealth is the goal for nearly all investors, but there are different ways to go about it. For some, investing is about finding assets that will rise in price, leading to substantial capital gains. For others, receiving regular income streams from a portfolio of investments is ideal. Focusing on generating steady investment income is known as an income investing strategy.
Investors might be interested in income investing for various reasons. Some investors want to create an additional income stream during their working years. Other investors may focus on generating monthly income during retirement. Whatever reason investors may have for choosing an income investing strategy, it’s important to understand how it works.
What Is Income Investing?
An income investing strategy is an approach to investing that focuses on generating income rather than capital gains. Income investors typically seek out investments that provide a regular income stream, such as dividends from stocks, interest from bonds, or rental payments from a property.
Income investing can be a way to generate a passive income stream that supplements labor and retirement income.
Types of Income Investing
There are several income investing strategies that investors can adopt, depending on their goals and preferences. Common approaches include investing stocks that pay regular dividends, bonds, and real estate.
1. Dividend stocks
Dividend stocks are stocks that pay out regular dividends to shareholders. Companies usually pay dividends quarterly, and they can provide a reliable source of income for investors. Income investors are generally attracted to companies that pay out reliable dividends, like the companies in the S&P 500 Dividend Aristocrats index. Companies in this index have increased dividends every year for the last 25 consecutive years.
One metric that income investors should consider is the dividend yield. A stock’s dividend yield indicates how much the company annually pays out in dividends to shareholders, typically expressed in a percentage of its share price.
While a high dividend yield might be attractive to some investors, risks are also associated with high yield investments. Investors who want regular and consistent income tend to avoid stocks that pay high yields in favor of dividend aristocrats that may pay lower yields.
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Bonds are a debt instrument that normally pays periodic interest payments to investors. Also known as fixed-income investments, bonds are typically less risky than stocks and can provide a steady stream of income. The bond’s yield or interest rate determines the interest income payment.
There are various bonds that fixed-income investors can consider. For example, government bonds are debt securities issued by a government to support government spending and public sector projects. Government bonds — like U.S. Treasuries and municipal bonds — are generally less risky than other types of bonds and can provide tax-advantaged income and returns.
Investors can also lend money to businesses through corporate bonds, which are debt obligations of the corporation. In return for money to fund operations, companies pay periodic interest payments to investors. Corporate bonds carry a relatively higher level of risk than government bonds but also provide higher yields.
However, not all bonds offer yield to investors interested in generating regular income. These bonds, called zero-coupon bonds, don’t pay interest at all during the life of the bond. The upside of choosing zero-coupon bonds is that by forgoing annual interest payments, it’s possible to purchase the bonds at a deep discount to par value. This means that when the bond matures, the issuer pays the investor more than the purchase price.
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3. Real estate
Real estate may be a great source of income for investors. Rents paid by tenants act as a regular income payout. It also offers long-term price growth, in addition to some tax benefits.
There are several ways to invest in real estate, including buying rental properties and investing in real estate investment trusts (REITs).
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4. Savings accounts
Savings accounts are a safe and easy way to earn interest on cash. Savings accounts and other cash-equivalent saving vehicles like certificates of deposits and money market accounts typically offer low-interest rates. However, because these interest rates are usually much lower than the inflation rate, inflation eats away at the value of the money in these savings accounts. Still, they are a low-risk way to earn income.
5. Mutual funds and ETFs
Investors who don’t want to pick individual stocks and bonds to invest in can always look to mutual funds and exchange-traded funds (ETFs) that have an income investing strategy. There are many passively and actively-managed funds that invest in a basket of securities that provide interest and dividend income to investors. These funds allow investors to diversify their holdings by investing in a single security with high liquidity.
Example of an Income Investing Portfolio
When building a portfolio for any investing strategy, investors must consider their financial goals, risk tolerance, and time horizon. For income investors, it’s important to include a range of income sources by diversifying holdings. It may also be beneficial to utilize mutual funds and ETFs to get exposure to certain asset classes.
A potential portfolio for an investor with a lower risk tolerance may look like this:
|Percent of holdings
|Bonds (government and corporate)
|Rental property or REITs
|Cash (savings account, money market account, and CDs)
(This is an illustrative portfolio and not intended to be investment advice. Nor is it a representation of an actual ETF or mutual fund. Please consider your risk tolerance and investment objective when creating your investment portfolio.)
Benefits and Risk of Income Investing
Like any investing strategy, there are both advantages and drawbacks to focusing on earning income through investments.
The potential benefits of income investing include receiving a steady stream of payments, which can help to smooth out fluctuations in the market. Also, the price of some dividend-paying stocks and real estate may be less volatile than other assets, like growth stocks, which can help capital preservation and total return over the long term.
Investors who are pursuing an income investing strategy should understand the risks involved. In particular, they should be aware that investments that offer high yields may also be more volatile. The income from these investments may be less predictable than from more established investments, like blue chip stocks that pay out consistently reliable dividends. For example, a company with a high dividend yield may not be able to sustain that kind of payout and could suspend payment in the future.
When investing in bonds, investors need to know about the potential risks associated with fixed-income assets:
• Credit risk is when there is a possibility that a government or corporation defaults on a bond.
• Inflation risk is the potential that interest payments do not keep pace with inflation.
• Interest rate risk is the potential of fixed-income assets fluctuating in value because of a change in interest rates. For example, if interest rates rise, the value of a bond will decline.
Additionally, if investors take the income from their investment for day-to-day needs, they may miss out on the benefits of compound interest. Investors could reinvest the income they earn on certain investments to take advantage of compounding returns and accelerate wealth building.
Factors to Consider When Building Your Income Investing Strategy
Building an income investing strategy takes work and time. Before creating a portfolio, you need to define your financial goals and consider your timeline for when you need the income streams. Below are some additional steps you could follow to create an income investing strategy:
• Assess your risk tolerance: It’s important to determine whether you want to invest more heavily in riskier assets, like dividend-paying stocks that may fluctuate in share price, or relatively safer securities, like interest-paying bonds.
• Choose your investments: As mentioned above, potential options for income investors include bonds, dividend stocks, and real estate investment trusts (REITs).
• Monitor your portfolio: It’s critical to regularly check in on your investments to ensure they are still performing according to your expectations.
• Rebalance as needed: If your portfolio gets out of alignment with your goals, consider making adjustments to get it back on track.
When most people think of investing, they think of finding the next Amazon or Google, investing in the stock early, and hoping they see substantial share price appreciation. However, that’s not the only way to build wealth through investing.
An income investment strategy is another way to achieve financial peace of mind. Investing in dividend-paying stocks, interest-paying bonds, and other assets allows you to get the benefits of regular income streams and potential capital appreciation, not just the hopes of striking it big on growth stocks.
Ready to try your hand at investing in stocks, ETFs, and earning dividends? An investment account with SoFi Invest® allows you to trade stocks and ETFs with no commissions or participate in upcoming IPOs before they trade on the public market. Plus, fractional shares mean you can buy a piece of your favorite companies for as little as $5.
What’s the difference between income investing and growth investing?
Income investing is focused on generating regular cash flow through dividends, rent, or interest payments, while growth investing is focused on capital appreciation.
What is the best investment for income?
There is no single best investment for income. Income-producing investments include stocks, bonds, and real estate. Each has different characteristics, so it is important to consider risk tolerance, liquidity needs, and investment objectives when choosing an investment.
Is income investing a good idea?
Income investing may be a good idea for investors looking for a way to generate regular income from their investments. Additionally, income investing can be a good way to diversify one’s portfolio and reduce overall portfolio risk.
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