Income investing for cashflow. So, when we peel back all the noise, what we all need is income – steady, reliable, regular, passive, well diversified cash flow.
Coins in our pocket every single day.
Income investing is achieved by organising your investment portfolio to generate a steady stream of income. This income might come from stock dividends, coupon payments from bonds or interest-bearing accounts or income from other types of assets such as real estate or alternative investments.
Income Investing – how it works.
Income investing commonly thought of as a means of replacing active income in retirement, and that in itself is a valid reason to invest for income. Actually, income investing is a valid strategy to generate income at any stage of an investor’s life.
Income investing requires you to build an investment portfolio that allocates most of the portfolio to investments that generate a regular, consistent stream of income. Income investors are more focused on receiving ongoing cash flow from their investments rather than seeing only capital gains occurring with their holdings.
Pros & Cons of Income Investing for Cash Flow
There are always both pros and cons to income investing.
Pros
Additional income & personal cashflow
Income investing is designed to provide additional income at whatever stage of life it is required. It can provide income for a career break, semi-retirement or to support a new venture. For retirees – income from their investments can supplement other sources of income such as Social Security or a pension. Investment income can serve as a safety net for younger investors and as a supplement to their income from employment e.g. to support maternity leave or a sabbatical. Really, investment income can be used for any purpose the investor chooses.
Opportunities for capital appreciation
The investments throwing off income also can offer the potential for appreciation. Individual stocks and bonds, mutual funds and ETFs can all appreciate in value in addition to the income they provide. Reinvesting dividends, coupons and distributions will also support capital appreciation of the portfolio until such times as the income is needed.
Cons
Income Volatility
Dividend payments of stocks are directly linked to the company’s profitability and cash flow. Negative changes in the company’s financial situation can lead to reductions in the amount of the dividend payments.
Investing Risk
Investing comes with risks. Stocks, bonds, REITs, mutual funds and ETFs can all decline in value thus creating capital losses for investors. Stocks can decline in value based on specific developments related to a company or based on general stock market fluctuations. Bonds are susceptible to rising interest rates. Every type of investment has its own unique risks – even cash which is eroded by inflation.
Types of Income Investing
There are quite a few ways for investors to generate income and steady cashflow from their holdings.
Stocks that pay Dividends
These are stocks that pay regular dividends to shareholders. When thinking about which stocks to own, investors will want to look at the dollar amount of the dividend payment per share, but more importantly the dividend yield percentage of the stock. The dividend yield is the current level of annual dividend payments per share divided by the purchase share price of the stock. Most stocks pay dividends on a bi-annual or quarterly basis.
Like any stock, dividend-paying stocks have the risk that the share price can decrease based on the performance of the company. The dividend can also be impacted by the industry or sector the company is part of or from the overall performance of the stock market.
Bonds
Bonds are debt instruments. Bonds are issued by companies, governments, agencies and others to raise money. A bond is issued with a maturity date set in the future. In exchange for the money raised, the bond pays interest to the bond holder (you) at a specified rate, on a semi-annual basis.
For example, a bond with an initial offering price of $100,000 per bond that pays $5000 in interest on an annual basis will have a yield of 5%.
Bonds’ interest rates are meant to reflect the risk of their issuers. For example, Treasuries, which are issued by the United States Treasury, are considered to be low risk securities. Bonds issued by corporations are rated by bond rating agencies. For instance, the S&P investment grade ratings range from AAA to BBB-. Anything below this is considered non-investment grade. Ratings consider the issuer’s financial strength including their ability to continue making interest payments on the bonds and their ability to repay the principal on the bonds when they mature.
In addition to an initial offering, bonds can be purchased on the secondary market just like stocks. The price of a bond usually goes up or down inversely with the direction of interest rates. An increase in interest rates will cause the price of a bond to decline. We have seen this scenario play out recently during and post pandemic.
If you hold a bond to its maturity, you will receive the face value of the bond back. If you purchased the bond in the secondary market at a price that was above the initial face value, you will experience a loss in value at maturity. You will need to decide if the interest payments received from the bond over time will offset this loss in value.
Real Estate
Owning rental real estate, either a residential property or an industrial space like an office building can provide steady rental income to an investor. Real estate is very much more a hands-on investment than buying stocks or bonds. There are maintenance costs for the property, tenant management, repairs, insurance as well as property taxes. Real estate is also an illiquid asset because a property generally cannot be sold as quickly or easily as stocks, bonds or other exchange traded securities. Nevertheless, real estate can be an excellent investment if you do your analysis well.
Another way to invest in real estate is through a Real Estate Investment Trust or REITs. These are securities that generally hold a number of properties of various types. They may also hold mortgages (MREITs). REITs are traded like stocks and usually pay a steady distribution.
Money Market Funds
Money market mutual funds are funds that invest in a variety of money market instruments like cash, short-term government securities, repurchase agreements and other money market instruments. The yield on the fund will move up or down with the level of short-term interest rates. Many money market funds are currently yielding more than 5%, but only about a year ago this yield was well under 0.5%.
These funds are very liquid like many other exchange traded funds. These funds can be sold, and the money is generally available the next business day or soon thereafter.
Mutual Funds and ETFs
Mutual funds and ETFs (exchange traded funds) are both types of pooled investments that hold securities like stocks, bonds, REITs, alternative investments etc. Some funds are actively managed, others are index funds where the securities held track an underlying index. For example – a very common index is the S&P 500 index.
Mutual funds and ETFs offer professional management and they are somewhat diversified because they hold a number of different securities, not just one stock.
A mutual fund trades only once at the end of the trading day. An ETF trades throughout the trading day just like stocks.
There are a number of ETFs and mutual funds that invest specifically in dividend-paying stocks. Some ETFs focus on the highest yielding stocks, other ETFs focus on stocks that have a continuous record of paying dividends, whilst other ETFs focus on dividend growth.
Mutual funds and ETFs that focus on bonds can provide a steady stream of dividend income as well. There are several types of bond funds focusing on broad indexes or specific types of bonds like corporate bonds or private debt or even mortgage debt.
The risk of bond funds is that they are susceptible to the impact of rising interest rates. These bond funds can decline in value when interest rates rise and the value of shares in the fund may never recover your purchase price.
So, there is a brief write-up of income investing for cash flow. What we all need is income – steady, reliable, regular, passive, well diversified cash flow.
Cheers
