Source: sxc.hu Photo: penywise

Source: sxc.hu Photo: penywise

Many of us think of investing as something that we do now, so that it pays off later. Often much later — at retirement. However, there are those who make a regular living, or supplement a main source of income off of their investments. This practice is called income investing. While some income investors are taking a hit right now, the basic principle is that you can generate income streams through careful thought out investments that offer reasonable annual returns with relatively low risk. This income is then used to pay bills, take vacations, shore up the emergency fund or even reinvested.

Putting together an income portfolio

It is important to note that any investment portfolio should represent your goals, and take into account your risk tolerance. You should have a portfolio with diversity in terms of asset class and sectors. This will help shield you from drops in a particular area of your portfolio. You should also realize that no portfolio is completely loss proof. You will have to understand that at some points in the economic cycle you will receive less income than at other times. This means that you will have to be ready to accept a lower income some quarters. An emergency fund in an FDIC-insured, high-yield savings account or a CD ladder is a good idea.

Types of investments that make good additions to income investment portfolios:

  • Dividend paying stocks should be a prominent part of your income investing plan. Every time a dividend is paid, you will receive the cash. Successful dividend investing for income requires that you buy stocks in companies that pay regular incomes. You want these companies to be solid, with a track record of positive earnings, competent management and periodic dividend increases. This will increase the chances that dividends will keep coming, even during times of recession. Indeed, there have been some companies that have kept dividends relatively steady throughout this recession — and some have even increased their dividends. Capital appreciation is an added benefit of investing in dividend paying stocks.
  • Bonds can provide a bit more of a stable income. Bond investing involves you lending money to some organization, be it corporate or government, at a fixed rate of interest. Remember, there is no guarantee of your principal unless you are investing in ultra-safe, highly rated bonds or commercial paper of very short duration. In many cases, if you pick bonds of a solid and stable company or government, you at least get back what you put in. Bonds mature in different time frames, so you should consider planning accordingly. There are also bond funds which can provide you easier and more regular access to your earnings. Some bond funds even come with the ability to write checks. There are also bonds (municipal bonds) that offer tax advantages. Corporate and municipal bonds are riskier than federal government bonds, but they provide higher returns. If you have a really high risk tolerance, you might even consider foreign bonds.

Other options for your income investing portfolio include real estate (buy property and rent it out or invest in REITs), currencies and some ETFs. Person-to-person lending is also becoming more popular as method of income investing. However, these are riskier propositions, and you should be careful that you are not over-exposed in these areas.

Taking money out of your income investing portfolio

When you have an income investing portfolio, you need to be careful that you do not run out of money. Many financial advisors use a rule of thumb, called the 4% Rule, that states that you should not take more than 4% of your account balance out every year. If you have $200,000 in your account, therefore, you should not take out more than $8,000. Of course, this rule only applies if you never want to run out of money. It allows for your portfolio to have some fluctuations in returns each year.

If you have another job, or if you are not concerned about making sure you have plenty of money in 30 years, you can adjust your withdrawals. You should also take into account that things like inflation, taxes and market volatility that influence the “real” value of your income from investment returns.

Before put together your income investing plan, it is a good idea to take stock of your situation, consider your options, and speak with an investment or financial planning professional. And make sure you understand the tax implications of any investment strategy you employ.