Roger Wohlner is a writer and financial advisor with over 20 years of financial services experience. He writes about financial planning for Wealthsimple and for a number of financial advisors. His work has been published in Investopedia, Yahoo! Finance, The Motley Fool, Money.com, US News among other publications. Roger owns his own finance blog called 'The Chicago Financial Planner'. He holds an MBA from Marquette University and a Bachelor’s degree with an emphasis on finance from the University of Wisconsin-Oshkosh.
Investing for income means putting together a collection of investments—which can involve multiple asset classes and investment styles—that generate regular income for the investor.
What is income investing?
There are generally two ways to profit from investing:
Appreciation on the value of the investment, which results in a gain over what you initially paid for the investment when you sell it.
Periodic income payments in the form of interest or dividends from the investment. Interest might occur as frequently as monthly; dividend payments typically occur quarterly.
Not all types of investments offer both the possibility for appreciation and income payments. For example, some individual stocks don’t pay a dividend, which represent a reward of a steady stream of income for investors.
Some income-generating investments such as money market funds, CDs, and savings accounts pay interest on a regular basis but don’t offer the opportunity for price appreciation.
Income investors are looking for investments that generate regular income. Some examples of income-generating investments include:
Many stocks pay a quarterly dividend, which is a cash distribution made to shareholders out of the company’s earnings. Not all companies pay a dividend.
Stock price listings will generally list the stock’s current yield. This represents the stock’s most recently paid quarterly dividend per share divided by the current share times four. This is expressed as a percentage.
For example, the price per share of Apple stock as of a recent market close was $178.97. The most recent quarterly dividend per share was $0.77. Multiplying this dividend yield times four gives an annualized dividend per share of $3.08, this is referred to as a forward dividend yield. The percentage yield from dividing $3.08 by $178.97 provides the current yield of 1.72%.
Dividends are paid to shareholders of the firm’s common shares. This share class is the one we generally see quoted in the media. If a company also offers preferred stock, these preferred shareholders would be paid their dividends before shareholders of the company’s common stock. This might happen if there was an issue such as cash flow problems with the company.
Many experts suggest pulling together a portfolio of dividend-paying stocks as a way to build an income-oriented portfolio. We will discuss this a bit below, but one caution is the dividend-paying stocks are still stocks. These stocks may have a bit less price volatility than the market as a whole, but their price will likely still fluctuate based on the same factors as other stocks.
Besides buying individual stocks, there are a number of mutual funds and ETFs that focus on dividend yield, as well as stocks in companies that increase their dividend payouts on a regular basis.
Bonds are debt instruments issued by corporations, the United States Treasury, federal government agencies, states, municipalities, and other entities. They’re issued to finance operations or to fund capital projects. The issuer pays interest periodically on most bonds and then the principal (the amount you paid for the bond) is repaid at the end of a specified period of time. There are some bonds that do not pay interest but rather are bought at a discount of their face value, with the full value paid to the bond holders at the end of a specified time period.
A typical corporate bond will have a face value of $1,000. Interest payments will generally be made every six months. A corporate bond with a 3% yield and a $1,000 face or par value would pay $15 interest per bond every six months. At maturity, the bond would be redeemed by the issuer, and the bond holder would receive their $1,000.
Bonds can be purchased as new issues or, in many cases, bought and sold on the secondary market much like stocks. The price will fluctuate based on the direction of interest rates. The yield for an investor on a “used” bond will be the interest paid by the bond issuer (which doesn’t change) divided by the price paid by the investor.
Besides corporate bonds various types of Treasury securities issued with the full faith and credit of the U.S. government are very popular. These are considered among the safest types of debt instruments available.
Interest on bonds is usually taxable. A notable exception is the interest paid on municipal bonds, which is exempt from federal taxation. Additionally. the interest on many munis are exempt from state income taxes for residents of the issuing state.
The interest rate paid on bonds is a function of their rating. There are several bond rating agencies that assess the credit worthiness of various bond issuers. Investors need to consider the creditworthiness of any bond they are considering. The benefit of a higher interest rate can be more than offset if the issuer runs into financial problems and can’t make the payments.
Beyond buying individual bonds, there are many mutual funds and ETFs that invest in bonds of all types, such as corporate bond funds, municipal bond funds, and government bond funds.
Interest bearing accounts
Accounts with banks, brokerage firms, or other financial institutions generally offer a low-risk way to generate income. Money market mutual funds offer interest and generally a stable value of $1 per share. There are also money market accounts with banks and other institutions that will carry FDIC insurance.
CDs are saving vehicles that are offered by banks that usually offer a higher interest rate. CDs are generally held for a set period of time—say six months, 1, 3, or 5 years. You pay interest to the bank and you receive your original deposit back at the end of the time period. CDs generally charge a penalty if you redeem them early.
How to invest for monthly income
Using one or more of the types of income-generating investments discussed above, investors can build a regular monthly stream of income. Here are a few examples:
A bond ladder is generally used to stagger the maturities of several individual bonds, allowing the investor to continually reinvest maturing bonds. This insulates you against dramatic shifts in interest rates to an extent. Both corporate and treasury bonds tend to make interest payments on a semi-annual basis. Be sure to check the interest payment schedule for any individual bond you might be considering.
This same principle can be used to stagger the timing of interest payments. For example, one bond might make interest payments in January and July, another in February and August and so on. You might be able to compile a portfolio of individual bonds that offer an interest payment in each calendar month.
While stock dividends are generally made on a quarterly basis, dividends can cover four months of the year and can be used with other income-producing investments like bonds or a money market fund to round out a monthly payment schedule.
Mutual funds and ETFs
Mutual funds and ETFs are collections of stocks, bonds and other securities. They will make periodic distributions of dividends, interest payments, or capital gains, mostly on a scheduled basis. Each fund and fund company is different, so investors who looking at mutual funds or ETFs as part of their income investing strategy should check the fund’s site to see when distributions have been made in the past to try and gauge how the timing of the distributions might work and how this fits into your income goals over the course of a calendar year.
Money market mutual funds, money market bank accounts, savings accounts, and CDs can all be part of an income investing strategy.
But all accounts are different.
For example, most CDs allow the account holder to choose between having the interest payments deposited into their account or having the interest payments sent to them. Money market funds and accounts, as well as savings accounts will generally deposit the interest payments into the account. Investors seeking to use these interest payments as part of a monthly income stream will need to withdraw those amounts from the accounts on a monthly (or other) basis themselves.
Fixed income investing
Investing in stocks is generally all or at least in part about the potential for growth from the appreciation of the stock. Even companies who pay healthy dividends offer the potential for share price appreciation.
Fixed income investing is about investing for income. Although the mechanics of different types of fixed income investments may vary a bit, in general fixed income investing involves investing a sum or money, receiving periodic interest payments on that money, and then receiving the amount invested back at the end of the investment’s term.
This is exactly how bonds work. Corporations, the U.S. Treasury, government agencies, states, and other entities issue bonds as a way to finance ongoing operational needs or to fund specific projects. The maturity of the bands can range from a matter of months to 30 years or longer. Interest will be paid over the time the bonds are outstanding, the bond issuer will repay the amount of the bond to bondholders at the designated time of maturity.
Bond interest rates will vary based on a number of factors including:
Time until maturity, longer-term bonds will usually carry a higher interest rate due to uncertainty of what will happen out into the future.
Risk of the issuer, riskier issuers will need to offer a higher of interest.
Fixed income investors can use bonds and other fixed income investments to meet some or all of their income needs. But like all types of investments, it’s important the fixed income investors understand what they are investing in, including the risks.