What is investment income?
If you’re wondering what is investment income and how important is it for your retirement, consider the fact that most of us simply don’t have enough in savings to just bleed down the balance every month after we quit working. Instead, we need income-generating investments that produce a regular “paycheck” of sorts while we are in retirement. Even if this investment income isn’t enough by itself, it does reduce the amount of cash you have to withdraw each year from your savings. That makes your savings stretch much further. Similarly, if you’re not at or near retirement age, investment income can be a steady stream of extra cash into your nest egg that doesn’t rely on market dynamics. So regardless of your age, strategy or portfolio value, income investing is important to consider. Here are seven ways to get started.
Arguably the most common flavor, bonds are popular income-generating investments. That said, bonds are also one of the most varied and complicated asset classes. There are government bonds that involve loans to local municipalities, the U.S. federal government or even foreign governments. There are also corporate bonds that involve loans to enterprises of all shapes and sizes. And finally, the yield generated by a given bond varies based on the specifics, including a borrower’s risk profile and the maturity of the bond. Properly researching individual bonds can be quite a task. As a result, most individual investors instead opt for bond funds such as the iShares Core U.S. Aggregate Bond ETF (ticker: AGG), which holds around 8,300 different bonds across all different segments of the market.
Dividend stocks are generally riskier than bonds, since companies pay them out of their profits. As the financial crisis of 2008 demonstrated, even the most stable companies can have a crisis that dries up profits. Consider megabank Citigroup (C), which slashed payouts from 54 cents a quarter in 2007 to a measly penny per share after the financial crisis. Still, many income investors are willing to take on this extra risk if it means they can enjoy the potential of a regular payday with the long-term hopes of seeing their initial investment grow alongside the rest of the stock market. Dividend stocks can be a win-win when they deliver capital appreciation and consistent income.
Preferred stock is a kind of hybrid investment between stocks and bonds. This income investment is less stable than bonds, since the stock value can fluctuate with market forces. Preferred shares take a back seat to bondholders in the event of bankruptcy, but they offer more stability than common shares. And income investors will be particularly interested in the fact that these assets tend to provide a significantly higher yield. As the name implies, preferred stock isn’t just handed out to anyone and can be difficult for individual investors to directly purchase. Luckily, several exchange-traded funds — such as the iShares Preferred and Income Securities ETF (PFF) — allow you to invest in this asset class with only a modest amount of cash.
You can attempt to buy rental properties directly, but that tends to require a lot of capital up front and doesn’t allow for a lot of liquidity as your investment is tied up and not easily accessed if you need the cash. As a result, many income investors prefer the strategy of investing in publicly traded real estate stocks instead. There’s a special class of stock known as the real estate investment trust, or REIT, that grants favorable tax treatment to a corporation if it distributes nearly all of its net income to shareholders. Investors can buy individual REITs such as Simon Property Group (SPG), the largest shopping mall operator in the U.S., or put money in a fund like the Vanguard Real Estate Index ETF (VNQ) for ease and diversification.
Asset allocation funds
If you can’t decide how to build an income portfolio with some or all of these publicly traded investments, then consider a one-stop investment fund that will build the portfolio for you. These include a variety of asset allocation ETFs and income-oriented mutual funds. Take, for example, the actively managed Invesco Balanced Multi-Asset Allocation ETF (PSMB) — a “fund of funds” that invests around 45% to 75% of its total assets in equity ETFs and 25% to 55% in fixed-income ETFs and regularly rebalances to keep the mix right for market conditions. There are also the popular target-date mutual funds like the Vanguard Target Retirement 2025 Fund (VTTVX) that take a less risky approach each year as your potential retirement date approaches (in this case, the year 2025).
Annuities have exploded in popularity over the last 10 years or so, as these income investments promise guaranteed monthly or annual income for a retiree until the day they die. It sounds wonderful, but there’s a big catch: Annuities must be funded for many years in advance before you achieve any payout. This can come via a monthly payment like life insurance, or a lump sum up front — sometimes as much as 10 or 20 years before you are eligible for your first distribution. Annuities are powerful vehicles for some investors, but it’s crucial to read the fine print about your structure to avoid big upfront costs. It’s also important to understand the consequences of early withdrawal and the challenges of getting your initial payment back if you need it.
Interest-bearing savings accounts
The tried-and-true method of parking your cash at your bank or credit union to generate monthly interest payments should also be considered. With a guarantee by the Federal Deposit Insurance Corp. up to $250,000, these are perhaps the most certain income investments on the planet. The trade-off for that safety comes in the lower yield. A one-year certificate of deposit, or CD, account offers about 0.2% in potential income at current rates, which would amount to $500 annually on that FDIC-insured maximum of $250,000. Unless you have other sources of income or wealth, a CD alone likely won’t grow your nest egg or provide the cash you need in retirement, but it is perhaps the safest of all these instruments.
Seven ways to invest for income:
— Dividend stocks.
— Preferred stock.
— Real estate.
— Asset allocation funds.
— Interest-bearing savings accounts.
More from U.S. News
Update 01/04/21: This story was published at an earlier date and has been updated with new information.