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We’ve all got that one friend who has it made. He works a 9 to 5, but not because he’s struggling to make ends meet. He lives lean, putting the lion’s share of his income into savings and investment accounts. He constantly buys and sells property, stocks, and other investments.
He takes his family on tightly budgeted trips at least three times a year.
He doesn’t look rich—you won’t find a BMW in his garage, and there are holes in his 10-year-old Columbia jacket—but he is.
He’ll be able to drop the 9 to 5 by the time he’s 40 and live purely off his income investments.
You want what he has.
What if we told you it’s within reach?
With income investing, you can work toward your own financially free life—without sacrificing fun and games in the process.
What exactly is income investing?
Income investing is a financial strategy for making investments that provide a steady income stream. It’s a particularly powerful strategy for people who are doing well financially and want to take things to the next level by increasing that financial comfort to open up new freedom in their lives.
You can divide these investment income types into three general categories: interest, dividends, and real estate income.
Let’s examine each one.
Interest
You earn interest by lending money to another person, entity, or company.
If you’ve ever taken out a mortgage on a house, you’ve had to pay an interest rate expressed as an APR (annual percentage rate). That interest rate is the money your lenders get as payment for lending you the cash for your house.
So if your mortgage has a 7% APR on a $150,000 mortgage and you pay it off over 30 years, your lender will make over $200,000 in interest and get back the original $150,000.
So, imagine the inverse of this situation. Instead of being the borrower, you’re the lender who earns that $200,000 in interest over the loan’s lifetime.
That’s the basic idea of using interest in your income investing portfolio.
The common types of interest investing include:
- Bonds: When you buy a bond, you lend money to a corporation, municipal government entity, or the federal government. That entity—the issuer—pays you a fixed interest rate in return. The issuer also agrees to repay the bond’s principal by a specific date, known as the maturity date. You typically receive interest from bonds twice a year.
- Certificates of Deposit (CDs): A CD is an agreement between you and a bank. You agree to leave a specific amount of money in the bank for some time. The bank, in turn, pays you interest on that deposit. Depending on the agreement, banks pay out CDs at the maturity date or throughout the year.
- High-Yield Savings Accounts: A standard savings account offers an APY (annual percentage yield) of about 0.10% interest. On the other hand, a high-yield savings account usually offers something closer to 4 or 5% APY once you hit a specific balance in the account. Many high-yield savings accounts pay interest every month.
- Money Market Accounts: This type of account is much like high-yield savings, except that it functions more like a checking account than a savings account. Money market accounts tend to come with a debit card and checks, making it easy to access the money. These accounts usually pay interest monthly.
Interest-earning income investments carry lower risks than other types of income investments. The FDIC backs a good high-yield savings or money market account for up to $250,000.
Dividends
A dividend is a portion of a company’s profits paid to its shareholders. You can become a shareholder by buying a share of the company’s stock—essentially a piece of the company.
Making stocks a part of your income investment portfolio can be incredibly rewarding. But stocks also carry a higher risk than bonds or CDs. Therefore, it’s essential to understand your own level of ‘risk tolerance,’ and what that means for the types of investments that make the most sense for you at this point in your financial journey.
For a steadier income stream, consider investing in dividend aristocrats. These are companies with a track record of paying dividends and increasing the amount of those dividends for at least 25 years. McDonald’s, Johnson & Johnson, and 3M are all dividend aristocrats.
Another option to explore is high-dividend stocks. These companies pay out higher dividends relative to the rest of the market. A dividend yield is the ‘marker’ for this payment type, a percentage calculated by dividing a company’s annual dividends by its stock price.
So, if it costs $100 to buy a share in Company A, and you receive $10 in dividends throughout the year, the dividend yield is 10%. If Company A has a 10% dividend yield and Company B, a dividend aristocrat, has a 5% dividend yield, then Company A is the high-dividend stock.
But just because a company starts the year with a high dividend yield doesn’t mean it’ll end the year with one. Ensure you assess the risks and benefits of dividends before adding them to your income investment portfolio.
Real Estate Income
Owning and renting out properties is a popular form of income investment.
How many people do you know who plan to rent out a condo, house, or apartment at some point in their lives? Or who already does?
Probably several.
And it’s easy to see why.
Say you buy an apartment for $200,000. You put $50,000 down. The remaining $150,000 goes on a 30-year fixed mortgage with a 7% interest rate.
This scenario means you now need to pay $998 a month for the next 30 years. But you already own a home and have paid it off. You plan to rent out the apartment for $1,400 a month. This cushion will cover the mortgage and other miscellaneous apartment expenses. It gives you a little bit to re-invest in your other income investments.
Fast forward 30 years—or sooner if you pay the mortgage off faster. You’ve paid off the mortgage. All you have to do is keep tenants in your unit, pay insurance premiums and property taxes, and keep your repairs fund stocked.
The rest goes straight into your pocket.
Of course, this is just a hypothetical situation. Your situation will vary based on dozens of factors, including the rental market in your area. Make sure you do serious number crunching before committing to becoming a rental owner.
Another real estate investment strategy is to buy a house or property cheaply, renovate it, and then sell it at a higher price. AKA, house flipping. This strategy involves a lot of elbow grease, so only do it if you love renovating homes and are comfortable with risk.
Tips for managing your portfolio
Income investing comes with many perks: a steady income stream from somewhere other than your 9 to 5. But it can also get confusing, especially as your portfolio expands and you begin earning income from your investments.
So, how can you keep track of everything?
You have to treat your investments like a business.
Take accounts payable departments, for example. An accounts payable (AP) department is responsible for processing invoices and paying vendors. Keeping your AP organized is essential to a company’s reliability and reputation.
Similarly, keeping your investments organized can help you avoid disastrous mistakes and keep growing that money. Consider using portfolio management software, like Quicken or Kubera, to keep track of your investments.
You can also use data-as-a-service (DaaS) principles to stay on top of your investment income portfolio. Data as a Service (DaaS) is any cloud-based service where you can access data stored online. It’s like the Blockbuster of data. Instead of buying and storing every movie you want to see, you can rent a movie, watch it, and return it to Blockbuster for storage.
(Yes, we know Blockbuster is no longer a thing. But let ye olde millennials have our moment of nostalgia, please.)
So it is with data. Instead of finding, organizing, cleaning, and storing it yourself, you can view it on the cloud, gain the insights you need, and get back to work.
Many software services that help you manage your investment portfolios also function as DaaS providers. They offer statistics that show how well your portfolio is performing, for example, and can also give you data that helps you decide what to invest in next.
The best perk of income investing
With careful planning and data-driven decision-making, investing can help you achieve financial freedom. Eventually, you could replace part—or all—of your 9-to-5 income with dividends, interest, real estate income, or a mix of all three.
The beauty of income investing is there’s something for everyone. Do you hate taking risks but love the idea of earning interest? Start a high-yield savings or money market account. Love the concept of bigger payouts but hate the thought of managing rental properties?
Buy stock from dividend aristocrats.
Just make sure you stay organized and informed every step of the way.