If you’re working toward financial independence, income investing may be right for you.
Income investing is when you build an investment portfolio that produces enough of a profit that it can pay out an income on a regular basis. Your portfolio isn’t made up of the hot new stocks, but rather safe and secure investments that have a long history of stability.
“An income-focused investor isn’t really looking for the next Amazon or Tesla,” says Kevin L. Matthews II, author and founder of BuildingBread, an investing education company. “They’re more focused on investments that pay out solid dividends with less volatility.”
Even though income investing sounds like a great way to invest, there are some downsides. Read on to learn more about income investing and what you should look out for when trying this strategy.
What Is Income Investing?
Income investing is when your investments work for you, giving you a regular paycheck. Income investments may consist of securities and assets like dividend-paying stocks, bond yields, and interest payments. This helps create streams of passive income, or money that comes from owning assets.
There are many ways to add income generating assets to your investment portfolio. Buying real estate, or real estate funds called REITs, is considered an income investment because it can generate income. So can dividend-paying stocks, or stocks that return money to their shareholders.
Advantages of Income Investing
Investing in and of itself has some risk, but income investing can have some major upsides, including less volatility.
”When the stock market falls, investors who are following an income strategy will usually feel less pain because their assets are in sectors that are in essential areas of the economy like real estate and utilities,” Matthews says.
Risks of Income Investing
Just as there are upsides to income investing, there are downsides.
“No investing strategy is perfect,” Matthews says. “One of the main risks, especially this year, is inflation. If your income is steady but the cost of living increases then your purchasing power will fade over time.”
Also, some companies cut dividend payouts if times get tough, which means your income could suffer.
“Like all investors, you will need to pay attention to the health of the company,” Matthews says. “Some companies have cut or suspended dividends when faced with challenges and would have a severe impact on your potential income.”
Check out each company’s history before buying shares of the stock. If they’re volatile, they might not produce the same returns as a company that shows a long history of solid performance.
Another major downside for income investors is that because you are reaping the benefits of this income and having it go into your wallet, you are not reinvesting that income back into the stock market. This prevents compound interest from working its magic. When you have money in the stock market, the best thing to do is let it compound on itself. Over time, you can build a really solid lump sum that you can use for retirement.
Strategies for Income Investing Beginners
If you’re thinking about income investing, know that it takes a long time to build enough wealth to generate a consistently high income. Having a clear and focused investing strategy will prevent you from making rash decisions and help you stay on track long-term.
“As a beginner you’ll want to be aware of the trade-offs between income investing and growth investing,” Matthews says. “In my experience, new investors come into income investing with the idea that owning a few shares of a company will provide them with enough income to live on. It usually takes several thousands to produce a meaningful income with this strategy.”