When investors think about the stock market, they often think about buying low and selling high. While this investment strategy can certainly pay off, there is a significant amount of uncertainty involved. So, how can you make the stock market a little more reliable? It’s called income investing.
The stock market can build a foundation for a comfortable retirement. You can reinforce that foundation by looking for investments that not only have upside potential when it comes to the stock price but also provide the opportunity to generate a predictable income stream. That’s what income investing is all about.
And the right investing strategy will not only help you secure peace of mind when it comes to your personal finances, but it can deliver on something even better — passive income.
To enjoy the benefits of passive income from income investing, you’ll need to build an income portfolio of strategically selected income-producing assets. We’ll show you what income investing looks like, who the typical income investor is, and three types of income investments.
What Is Income Investing?
Income investing generates passive income. And passive income is exactly what it sounds like. Cash comes in while you’re at work earning other forms of income. And then, when you retire, you have a steady stream of income.
So, you just sit back and watch as an income stream pours into your bank account. Not bad, right?
With the buy-low, sell-high investing approach, you’re essentially eliminating all potential future benefits once you sell the investment. It’s like a farmer ripping out all of the crops at harvest time rather than just harvesting the fruits — and vegetables perhaps — of their labor.
Income investing, on the other hand, lets the initial investment stay put while harvesting proceeds from passive income. This way, the underlying investment can continue to grow and produce more income. Think of it like the farmer harvesting their bounty and letting the crops continue to grow and produce more for the future. It’s buy and hold at its best.
Who Is the Typical Income Investor?
Income investing is generally associated with older investors approaching retirement or retirees themselves. Age-based investing options typically shift investment portfolios from growth to income as the investor ages.
Why? Because the longer you can let your investments grow without touching them, the more risk the portfolio can tolerate, which often translates into higher rates of return.
But all investors can benefit from including income producers in their portfolio, even if just for the sake of offsetting aggressive growth assets.
4 Types of Income Investments
Income investments exist in many different assets classes. Below, we’ve outlined four income investments that, when diligently selected, can produce cash flow with a reasonable amount of risk and serve as a stable foundation of your income portfolio.
Dividend stocks are stocks issued by companies that make regularly scheduled cash payments to investors. The payments are on a per-share basis and depend on how profitable the company is at the current time.
Just like with any stock, of course, the investor hopes that the stock price will appreciate over time. But dividend stocks provide an income stream that not only adds to the benefits of holding that stock but can offset risk in times of market volatility.
So, if the stock price plummets one day because of external market conditions, like a global pandemic let’s say, dividend stocks provide a buffer, so you’re in no rush to rip up your crops by selling your shares.
Plus, when dividend stocks are strategically selected, you don’t have only one harvest season. Instead, your income portfolio will have several dividend payouts during the year. This is especially helpful for retirees looking to manage cash flow by coordinating dividend payments with their lifestyle.
Real Estate Investment Trusts
Real estate itself can provide solid cash flow. But there is a lot of work involved in this type of investment. Because we’re trying to find truly passive income for you, we’re going to give you an even better option — real estate investment trusts (REITs).
REITs are an interesting option for investors who want to invest in real estate but don’t want the hassle of actually buying or managing the property. Investing in a REIT stock also enables investors to spread their investment risk among several properties instead of investing in a single property.
When you invest in a real estate investment trust you buy shares in a publicly traded company that invests in a variety of projects. The REIT pays out dividends much in the way stocks do. The dividends can vary in both amount and frequency.
Similar to the way mutual funds operate, REITs pool money from investors and invest in real estate projects like office buildings, shopping malls, resorts, and apartment complexes. Then, your investment represents partial ownership in the REIT’s underlying properties.
REITs are attractive to investors seeking higher yields than other traditional fixed income investments. By law, REITs are required to pass at least 90% of their taxable income on to their shareholders. The most successful REITs have a reliable track record of paying significant dividends and have the potential for even more dividend growth.
Bonds were wildly popular in the 1980s. Now, because of low interest rates, these fixed income securities aren’t as attractive to investors seeking instant gratification. Investors have turned their attention to equities and other more exciting asset classes.
Nevertheless, there are still many investors who use bonds in their portfolios to generate passive income.
Bond investing has seen a resurgence thanks to the growth of exchange-traded funds (ETFs) and mutual funds that focus on bonds. These bond funds enable investors to invest in bonds without having to research individual bonds.
Plus, there is more liquidity than the traditional bond investment process since the fund, not the investor, is the one who commits to the length of the bond term. Investors can sell ETFs or mutual funds at any time.
So, how do bonds work?
Bonds are essentially loans investors make to bond issuers. If the issuer is the government, you’ll purchase government bonds or municipal bonds. And if the issuer is a company, you’d be purchasing corporate bonds.
The investor then earns income through fixed-interest payments on a regular schedule. When the loan term ends, the investor receives the original loan amount back.
Typically, the longer the term, the higher the interest rate.
Bond prices generally trend up when the stock market goes down, so bonds can be a great way to ensure diversification of your investment portfolio.
Income-Oriented ETFs and Mutual Funds
We discussed ETFs and mutual funds that focus on bonds, but income-oriented ETFs and mutual funds are also available. Just look for the words “income” or “high yield” in the names.
These funds invest in everything income-oriented, like real estate stocks, common and preferred stock, corporate bonds, and municipal bonds.
There are a variety of high-yield ETFs and mutual funds available. But ETFs are passively managed, so they’re forced to match the performance of the benchmark index. So managers are obligated to trade in a down market, even at unfavorable prices.
Some funds focus on diversification, while others boast high yields.
Another caveat is that high yield does not guarantee high quality. In fact, high yield often comes with elevated risk. Investors should keep in mind that high-yield funds may invest in bonds with low credit quality.
Pave the Road to Retirement With Income Investing
Perhaps the most successful investor of our time, Warren Buffett said in a letter to his shareholders, “Our favorite holding period is forever.”
Income investing is buy and hold at its best. Thinking like Buffett about long-term investments will help you pave the road for retirement.
Note: This article originally appeared at Investors Alley.