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Income Investing Strategy — What It Is & Tips for a Successful Portfolio


Investing is all about making money. The idea is to buy assets and hold them until they become more valuable, then sell them to turn a profit. However, there’s a group of investment strategies that take earning money from investing to the next level. These investing strategies are centered around an idea known as income investing.

Income investors aren’t just looking for a stock, bond, mutual fund, or piece of real estate they can buy at a low price and sell at a higher price later; they’re looking for one that will yield cash throughout the term of the investment. Therefore, the investor participates in valuation growth while cashing a check on a regular basis.

Although income investing is most popular among those nearing or in the midst of retirement, it’s a great investing strategy for anyone who wants to earn consistent income in the real estate or stock markets while enjoying a relatively low-risk exposure to valuation growth.

What Is Income Investing?

Income investing is the practice of purchasing assets that are known for yielding income on a regular basis. The most common income investment — albeit a horrible one — is a savings account.

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After you make a deposit in a savings account, you’ll receive interest payments for holding your money at the financial institution that offers it. That interest rate will result in monthly payments to your account based on your account balance — monthly income.

Although a savings account is an income investment, it’s not the best option available. Even in a high-yield savings account, today’s interest rates are so low that your money isn’t likely to grow at the same rate as inflation, meaning that you’re losing buying power when you save money in a traditional savings account.

Instead, income investors take advantage of a wide range of investment vehicles that offer the potential for higher levels of consistent income. Some of the most common income investment vehicles are real estate, exchange-traded funds (ETFs), mutual funds, and dividend stocks.

Types of Income Investments

If you decide to take the income investing approach, you’ll have several options at your disposal. Some of the most common investment vehicles that are known for producing compelling income include:

Real Estate

Some of the wealthiest people in the United States either got their start or earned their entire fortunes in the real estate industry. In fact, it’s such a popular way to generate income that, according to CNBC, 35% of Americans see real estate as the most favorable long-term investing opportunity.

Real estate investors generate a return in two ways:

  • Passive Income. After purchasing a new piece of real estate, many investors renovate the property and put it on the market for rent. Every time a rent check is collected, the investor generates cash flow from the investment.
  • Price Appreciation. Real estate is known for relatively slow yet consistent growth in value. Therefore, not only does the real estate investor earn an income from rent charged to tenants, they also benefit from price appreciation as the value of the property grows.

Pro tip: If you’ve thought about investing in real estate, you can purchase turnkey properties through Roofstock. They’ll even guarantee you have a tenant within 45 days or they’ll cover the rent for up to one year.

Income-Focused Mutual Funds and ETFs

Most investors diversify their investments to avoid risk, whether they’re following an income investing strategy or another strategy. Mutual funds and ETFs are popular investment vehicles, as they add a high level of diversification to any portfolio. These funds invest in a wide range of stocks, protecting the investor from any significant losses associated with declines in any single asset.

As with any other type of investment fund, there are plenty of mutual funds and ETFs that are designed for income investors. These funds offer the safety associated with heavy diversification as well as a high dividend yield when compared to other mutual funds.

Some of the most popular high-yield mutual funds include:

  • T. Rowe Price Dividend Growth Fund (PRDGX)
  • Fidelity Equity Income Fund (FEQIX)
  • Vanguard Real Estate ETF (VNQ)
  • iShares Core Dividend Growth ETF (DGRO)
  • Vanguard Utilities Index Fund ETF (VPU)

Dividend Stocks

Another common way to go about income investing is by investing in dividend stocks, or stocks that make dividend payments to their investors. Dividend payments are a portion of the company’s earnings that paid out to investors after all expenses are deducted.

Dividends are declared by a company’s board of directors, and as long as you’re invested in the stock by the ex-dividend date, you’ll receive dividend payments on the next round.

However, not all stocks are dividend stocks. There is no requirement that any publicly traded company share its profits with investors. These profits may be used instead for research and development, investing in assets, improving infrastructure, and other needs.

So, simply owning stock doesn’t mean that you’ll be entitled to dividend income. If you’re taking the income investing approach, make sure that the stocks you invest have consistently declared dividends. There are many well-established companies in the consumer staples and utilities sectors that have a long history of paying solid dividends to shareholders.

Real Estate Investment Trusts (REITs)

A real estate investment trust, or REIT, is a publicly traded company that owns and in most cases operates income-generating real estate assets.

The funds to purchase and operate assets are driven by investors who purchase the REIT. As a result, the income generated through the assets owned by the REIT is shared with the pool of investors that made it possible, after management fees and other expenses, of course.

Some of the most popular REITs include:

  • American Tower Corp. (AMT).
  • Crown Castle International Corp. (CCI).
  • Prologis Inc. (PLD).

Tax Benefits of Income Investing

As a result of the long-term nature of this investing strategy, there are tax benefits that income investors enjoy.

Capital gains, or gains from investing activities, are taxed at different rates depending on how the investments are made. Long-term gains from assets you hold for more than one year are taxed at a more favorable rate; short-term gains from assets held for less than a year are taxed like normal income. For example, if you invest in a stock that climbs 10% in three months and you decide to sell your holding, the 10% gains you experienced are the capital gains of the investment. These capital gains will be taxed at the same rate as your personal income due to the fact that the investment was held for under a year before it was sold.

However, income investing is a long-term investing strategy. You’ll generally hold good income-generating investments for far longer than a year, giving you a reduced tax rate on your capital gains. Capital gains tax rates start at 0% and top out at 20% for high earners — a far cry from the top income tax rate of 37%.

Importantly, qualified dividend payments from dividend stocks are also taxed at long-term capital gains rates, offering passive income with a tax discount compared to traditional income.

Unfortunately, the tax benefits associated with income investing are not afforded to real estate investors. Any income generated from the rental of real estate will be taxed at your income tax rate based on your tax bracket. Fortunately, real estate investors enjoy a slew of other tax benefits.

How to Be Successful as an Income Investor

Although income investing ultimately leads to passive income, being a successful income investor requires a bit more than buying a few dividend stocks or a piece of property and cashing in. Here are the steps successful investors generally take when making an investment.

Step 1: Choose Your Investment Vehicle

Before you start investing, you’ll have to decide which investment vehicle or mix of investment vehicles you’ll want to involve in your investing strategy. When making this decision, consider the following:

  • Your Appetite for Risk. First and foremost, you’ll have to consider your risk tolerance. Although most income investments come with relatively low levels of risk, sometimes stocks have high dividend yields due to recent heavy declines. Moreover, investments in single stocks will always come with unique risks. Real estate investments can also turn south pretty quickly. If you’re a risk-averse investor, you may want to consider investing in heavily diversified, income-focused ETFs and mutual funds.
  • Your Investing Capital. Your investing capital will play a role as well. If you’ve only got a few hundred dollars to start with, you won’t have enough money to purchase a property for real estate investing. Moreover, there’s not much money to diversify your portfolio by choosing a group of single stocks that pay dividends. So, if your initial capital is under $10,000, you’ll want to stick to income-focused mutual funds and ETFs or REITs.
  • Your Willingness to Get Involved. If you decide to invest in real estate, you’ll need to take an active role in renting your properties out and maintaining them for your tenants. If you invest in single stocks that pay dividends, you’ll need to devote time to research and to undertaking monthly or quarterly rebalancing. If you don’t have the time to devote to these types of investments, income-focused ETFs, mutual funds, or REITs are the best way to go.

Step 2: Do Your Research

If you’re looking to generate high returns as an income investor, you’ll need to do your research before making any moves in the stock market or otherwise. After all, you’re not just looking for a good investment, you’re looking for an income stream that will grow over time.

Research for Dividend Stocks, Mutual Funds, ETFs, or REITs

If you’re going to take the stock market approach to income investing, there are a few key metrics you’ll want to look into before making an investment.

  • Dividend Yield. The dividend yield associated with dividend stocks, mutual funds, ETFs, and REITs is a ratio that compares the annual dividend paid by the financial instrument to the share price paid by investors. Any security with a dividend yield of 2.5% or greater is worth looking into.
  • Dividend Payout Ratio. The dividend payout ratio is the percentage of profits the company or fund pays out in dividends. High dividend payout ratios are considered to be between 50% and 75%. Although a high dividend payout ratio is appealing, it can also be a double-edged sword. If a company doesn’t use enough of its earnings to spur growth, it could plateau, and dividends could dry up.
  • Dividend Growth Track Record. A strong dividend investment will have a history of relatively stable valuation growth, with stable dividend growth to match. Make sure that this is the case in any dividend stock, mutual fund, ETF, or REIT you buy to increase your chances of successful investing.
  • Total Return. The total annual return on a security that pays dividends accounts for both the dividend payments and valuation growth. When investing, you’ll want to strive for a total return of 10% or greater, regardless of the investing strategy you choose to employ.
  • Other General Due Diligence. The key points associated with dividends are listed above. However, before purchasing any security on the stock market, it’s important to do detailed due diligence by carefully researching the underlying company.

Pro tip: Stock screeners like those from Trade Ideas or Stock Rover can help you pick investments that meet your specific requirements.

Research for Real Estate Investments

Real estate investments come with their own set of points to research. Most importantly, before you dive into any real estate investment, you should look into:

  • Recent Sales. Look into recent sales of comparable real estate in the areas that you’re considering buying. This will give you an idea of the fair market values of properties you’re interested in purchasing. Of course, you’ll want to dive further into opportunities to purchase real estate below fair market value.
  • Rental Rates. If you’re looking to flip houses, rental rates won’t matter, but if you’re using real estate as an income investment, you’ll want to consider what amount of income you can expect to receive by renting. Look for listings of comparable properties to get an idea of the monthly rates you’ll be able to charge potential tenants.
  • Vacancies. Your real estate won’t generate any income if nobody rents it. In some markets, you can’t keep a home or commercial property on the market because there’s so much demand. In others, it may take months or even years to rent your property. Search for vacancies in real estate similar to the property you’re considering buying. If there are a ton of options on the market, you may have a hard time finding a quality renter.
  • Property Condition. Often you’ll find opportunities priced far below market values only to find that the properties need quite a bit of work before they can be rented out. Although this is the best way to get a deal, it’s important to have a detailed understanding of the amount of money the work will cost before making an investment. Sure, buying a $250,000 house for $100,000 sounds great. But if there’s a foundation crack, plumbing issues, electrical issues, and a need for a roof repair, you may have to drain $200,000 into repairs before you’ll ever be able to rent it out. So, in the end, you’ll find yourself paying $300,000 for a $250,000 house. Doing your research prior to jumping on what seems like a great deal will save you from these kinds of mistakes.

Step 3: Make Your Move

Once you’ve done your research, you’re ready to make your move. If you’re looking to invest in the stock market, start buying the stocks, ETFs, or mutual funds that you’ve researched and believe to be the best options to meet your financial goals.

If you’re investing in real estate, it’s time to buy the property or properties that you feel fit in with your investing strategy and begin the process of renovating and renting.

Step 4: Stay on Top of Your Investment

Although income investing is all about putting your money to work to earn a passive income, it’s not always a passive activity. In fact, successful investors tend to be quite active, consistently staying on top of their investments.

In terms of real estate, successful investors put in quite a bit of effort with regard to property maintenance and tenant screening. They also tend to reinvest their income to grow their book of owned income properties.

Those who choose to invest in the stock market keep tabs on press releases and corporate filings associated with the dividend-paying securities they’re invested in. On a quarterly basis, successful investors rebalance their portfolio, updating their holdings to ensure that their investment portfolios stay in line with their financial goals.

Here’s a tip if you’re investing in real estate and earn rental income: Employ that rental income in the stock market to expand your gains and increase your buying power for when it’s time to purchase your next property.

Final Word

Income investing is an exciting concept. By putting your funds to work in the stock market or in real estate, you have the potential to experience both value growth and income, with tax benefits in many cases.

So, it’s not surprising that so many newcomers to the investing community are interested in income investing opportunities. However, before you dive in, make sure to do your research and gain a detailed understanding of each move you make in order to shield yourself from significant losses.

Joshua Rodriguez has worked in the finance and investing industry for more than a decade. In 2012, he decided he was ready to break free from the 9 to 5 rat race. By 2013, he became his own boss and hasn’t looked back since. Today, Joshua enjoys sharing his experience and expertise with up and comers to help enrich the financial lives of the masses rather than fuel the ongoing economic divide. When he’s not writing, helping up and comers in the freelance industry, and making his own investments and wise financial decisions, Joshua enjoys spending time with his wife, son, daughter, and eight large breed dogs. See what Joshua is up to by following his Twitter or contact him through his website, CNA Finance.