Income Investing: What It Is, How It Works & Strategies

By Martin Christensen
February 1st, 2024
14 minutes read

Income investing is a strategy focused on generating regular income rather than capital appreciation. Investors achieve this by building an investment portfolio with assets that generate recurring payouts, typically through dividends from stocks, interest from bonds, or rent from real estate properties. The aim is to achieve a stable cash flow while carefully balancing risk and potential return.

types of income investments

Key Takeaways

  • Diversified income portfolios contain investments like bonds, dividend stocks, REITs, annuities, and P2P lending.
  • Balance risk with DRIPs, bond laddering, ETFs, and P2P lending for a steady income.
  • Earn steady returns, complement income, and hedge inflation, but watch out for defaults and market changes.
  • Diversify your income portfolio to manage the risk and secure a steady cash flow.

What is Income Investing?

Income investing is a strategy in which investors focus on receiving regular income instead of solely aiming to increase the paper value of investments. Investors allocate their funds to investments that provide a recurring return. Additionally, investors diversify their portfolios to ensure a steady cash flow during market fluctuations. One of the most popular approaches to generating income is through dividend yielding ETFs.

From an analysis of the top 100 highest dividend yielding ETFs, it's observed that the average annual dividend return stands at approximately 20%, albeit with inherent risks.[1] Opting for a more secure strategy involves diversifying across sectors, perhaps through an ordinary index fund. For instance, the S&P 500 has offered an annual dividend yield averaging 2.88% since 1960.[2] Furthermore, investments in private markets like crowdfunding investments have emerged as an alternative investment vehicle beyond traditional assets and have become viable additions in the toolbox of income investors.

The objective of income investing is to establish a dependable cash flow, which can be utilized alongside other income sources or reinvested to grow the generated income further. By prioritizing income generation, investors aim to mitigate the impact of market fluctuations on their finances. However, it's essential to consider the balance between investment risk and potential return, as higher-income investments typically entail greater risk. Overall, income investing is suitable for investors seeking consistent income to meet their financial objectives, whether for immediate expenses or long-term wealth accumulation.

Types of Income Investing

Income investing offers diverse options: Bonds provide stability and regular income; dividend-paying stocks offer growth potential and dividends, REITs allow real estate exposure with liquidity, annuities ensure steady income, and P2P lending yields high returns but requires careful risk management.

Bonds

Bonds are like IOUs issued by governments, cities, or companies. When someone buys a bond, they are lending money to the issuer. In return, they receive regular interest payments and recoup their initial investment when the bond matures. Bonds are generally considered safer than stocks and provide a steady income. There are various types, including government bonds which are considered the safest[3], municipal bonds issued by local governments, and corporate bonds issued by large businesses. For instance, the US 10-year Treasury Yield is currently yielding 3.80%.[4]

Dividend Stocks

Dividend-paying stocks are shares of companies that distribute profits to shareholders as dividends. Investors benefit from regular income and potential capital appreciation. These stocks fall into two categories: high-yield dividend stocks, which offer higher dividends with increased risk, and dividend growth stocks. The latter initially yield lower dividends but have a history of increasing payouts over time, making them appealing to long-term investors. To put things in perspective, the S&P 500 annual dividend yield is ranging from 1.5% to 2.5%.[5]

Real Estate Investment Trusts (REITs)

Real Estate Investment Trusts are investment vehicles that own, operate, or finance income-generating real estate such as residential complexes, retail spaces, or industrial facilities. Investors receive dividends from property incomes. REITs offer diversified risk and liquidity, facilitating easy buying and selling. Two primary types exist, Equity REITs, which directly invest in real estate assets, and Mortgage REITs, which invest in real estate loans or debt.

Annuities

Annuities are special contracts bought from insurance companies, providing a steady income for a set period or a lifetime. They can be purchased with a lump sum or periodic payments. Two main types exist, Fixed Annuities, offering a guaranteed payout like a fixed paycheck, and Variable Annuities, allowing investors to allocate funds to different investments, potentially offering higher returns but subject to market risks. This type of investment vehicle aims to secure financial stability by either providing a fixed income or participating in market-linked gains, depending on the chosen annuity type and structure.

Peer-to-peer Lending

An emerging and alternative approach to generating income from investments is via peer-to-peer lending or lending-based crowdfunding. Income investing via private market lending entails investments in loans to individuals or businesses online, potentially yielding better returns than regular savings accounts or bonds. For instance, if we examine some of the popular lending platforms in Europe, such as Estateguru, Mintos, and PeerBerry, we find that the average interest rates range from 8.5% to 9.83%.[6][7]

Numerous lending platforms offer a variety of debt investment products, including consumer loans, business loans, and real estate investments. Investors select loans based on risk, diversify their investments to mitigate potential losses, and receive recurring interest payments. Lenders can opt to reinvest these payments to augment their earnings or withdraw them as income. While P2P lending offers flexibility, it requires careful attention to risk and ongoing management for optimal outcomes.

Income investing with peer to peer lending

Income Investing Strategy

Income investing focuses on creating a portfolio designed to generate steady income. The goal is to earn money regularly from investments. The idea is to prioritize generating consistent cash flow over seeking high returns. There are several different income investing strategies for income investors including Dividend Reinvestment Plans, Laddering Bonds, the Barbell Strategy, funds and private market lending.

Strategy

Description

Dividend Reinvestment Plan (DRIP)

A DRIP strategy maximizes income generation by compounding returns, dollar-cost averaging, automating reinvestment, and waiving transaction fees. By consistently reinvesting dividends, DRIPs accelerate portfolio growth, leading to higher future income by increasing the number of shares and dividends.

Laddering Bonds

Laddering bonds involves diversifying investments across bonds with staggered maturity dates, mitigating reinvestment risk, and maximizing income. It provides a steady cash flow and flexibility, while reducing the impact of interest rate changes. This strategy balances income generation with risk management, enhancing yields while spreading credit risk.

Barbell Strategy

The barbell strategy divides investments between high-risk (potential for big gains but volatile) and low-risk assets (stable income), balancing risk and reward for steady income streams with growth potential.[8]

Income-Focused ETFs and Mutual Funds

Income-focused ETFs and mutual funds diversify investments in bonds, dividend stocks, and REITs, managed by professionals for regular income. They offer reinvestment options, accessibility, liquidity, risk management, and tax efficiency, ensuring steady income while managing risks and maintaining liquidity for investors.

Peer-to-Peer (P2P) Lending

There are three approaches to maximize income generation with private market lending:

 

Auto-Invest: Utilize platforms' auto-invest features for efficient investing. Set parameters matching goals, letting algorithms lend on your behalf, saving time and ensuring a steady income.

 

Reinvesting: Instead of withdrawing, reinvest funds to generate passive income. Lend again to accumulate interest over time.

 

Portfolio rebalancing: Avoid concentrating funds in one asset. Diversify to spread risk. Regularly review and adjust investments for optimal performance.

Income Investing Benefits

Income investing represents a savvy approach for individuals to generate returns from their savings. Rather than allowing funds to remain stagnant in a bank account, this strategy puts money to work, yielding regular income.

A significant advantage of income investing lies in its ability to complement fixed income, which for most people consist of a salary or pension. This additional liquidity can be allocated towards daily expenses or earmarked for future financial goals.

Additionally, income investments have the potential to appreciate over time, contributing to long-term wealth accumulation. They also act as a hedge against inflation, safeguarding the purchasing power of funds. To sum it up, income investing provides a reliable means for individuals to earn steady returns, safeguard savings, and potentially enhance wealth over time.[9]

Income Investing Risks

Income investing, such as buying bonds, entails various risks. These risks include the possibility that the issuer may be unable to repay the investment, changes in the reliability or the liquidity of the bond, a decline in the bond's credit rating, and fluctuations in its market price. Additionally, changes in inflation and interest rates make it more challenging to predict investment returns and bond values. Reinvesting the proceeds from bonds at the same rates can also pose challenges. To manage these risks diversification is crucial.[10]

In addition to traditional investment avenues like bonds, stocks, and real estate, there is peer-to-peer (P2P) lending, where individuals lend money to one another through online platforms. While this can yield attractive returns, it also carries risks. These risks include the possibility of the borrower or platform defaulting, the platform ceasing operations, and borrowers failing to repay their debts. To mitigate these risks, it is essential to assess the ease of reclaiming invested funds, and potential fluctuations in interest rates, and to understand relevant regulations. Even with proper diversification across multiple loans, there remain risks associated with economic downturns and issues with lending platforms.

How can I generate income by investing?

Investing to earn money can be done in different ways. Some popular methods include buying stocks that pay dividends, investing in bonds that pay interest, and using Real Estate Investment Trusts (REITs) to earn from property without owning it directly. You can also lend money to others via peer-to-peer platforms for interest. High-yield savings accounts and annuities are simpler options. It is important to spread your money across different types of investments to lower the risks. Before investing, it's smart to research and perhaps talk to a financial advisor to make the best choices.

How to invest $100,000 for income

Investing $100,000 for income can be done by spreading it across different types of income investments for diversification, safety and profit. It all depends on your risk profile and you should consult a professional advisor before making any investment decisions. Here is a simple plan to follow a portfolio allocation model:

  • Put $30,000 (25%) into dividend-paying stocks for regular payouts.
  • Invest $25,000 (35%) in bonds for steady returns.
  • Allocate $15,000 (15%) to Real Estate Investment Trusts (REITs) for profits from real estate.
  • Another $15,000 (15%) goes into mutual funds or ETFs focusing on dividends.
  • Add $5,000 (5%) in preferred stocks for higher dividends. Secure $5,000 (5%) with annuities for reliable income.
  • Invest $3,000 (3%) in peer-to-peer lending for potential extra earnings.
  • Finally, keep $2,000 (2%) in savings accounts for quick access to cash.

Review and adjust your investments regularly to match your goals and needs. To put things in perspective, comparing the historical risk/return data from 1926 to 2021, a portfolio consisting entirely of bonds yielded an average annual return of 6.3%, while a portfolio with a mix of 20% stocks and 80% bonds delivered a higher average annual return of 7.5%.[11]

Are income funds a good investment?

Income funds are investments that pay you money regularly, typically monthly or quarterly. They can be good for beginners because they provide steady returns with high diversification. There are different types of income funds. Many invest in safe assets such as government bonds, blue chip stocks or real estate. Some are safe but offer low returns, while others might give you more money but come with a higher risk. Common for them all is that you will typically pay a significant fee for the management. It is important to understand what you are investing in and how it might change over time. Income funds are best for people who want to make money regularly without having to select individual investments themselves.

Article Sources

  1. VittaFi ETFdb: “Top 100 Highest Dividend Yield ETFs”
  2. NYU Stern School of Business: “S&P500 Performance from 1960 to current year”
  3. Schroders: “An Investor’s Guide to Bonds and Fixed Income”
  4. Bloomberg: “United States Rates & Bonds” YCharts: “S&P 500 Dividend Yield”
  5. YCharts: “S&P 500 Dividend Yield”
  6. Estateguru: “Statistics and Reports”
  7. PeerBerry: “Statistics”
  8. Insperex: “Bond Ladders & Bond Barbells - Bond Ladders”
  9. Johnson Asset Management: “Equity Income Investing: Beyond Dividend Yield”
  10. ARDEA Investment management: “How are fixed income strategies impacted by the market environment?”
  11. Vanguard: “Vanguard portfolio allocation models”