Income Investing—Not Just for Retirement
Having your investments serve as a source of income can be useful in a number of ways. Let’s walk through the essentials of an income investing strategy.
Key Takeaways
A portfolio of different types of securities may give you a smoother, more consistent level of regular income than a single asset class whose yield may vary widely.
Investors seeking sustainable income need to find the right balance between income and total return potential that aligns with their financial goals and risk tolerance.
We offer several multi-asset income solutions managed by professionals knowledgeable about the multiple risks investors face.
Think investing for income is just for people in retirement? Think again.
Having a portfolio that offers the potential for a steady stream of cash can be used for a variety of purposes in life, including:
Paying for a large, planned expense like college
Supplementing monthly living expenses
Funding a big purchase, like a home
Building up an emergency fund
The switch from investing for the growth of your savings to spending it can raise a few questions. Let’s walk through the essentials of income investing, the types of investments that generate income and key strategies for maximizing your income potential and managing the risks.
What Is Different About Income Investing?
Income-generating assets vary not only in their average yield but also in income consistency. In other words, the level of income can fluctuate in response to risk and changing market and economic conditions.
A portfolio of different types of securities may give you a smoother, more consistent level of regular income than a single asset class whose yield may vary widely.
Know Your Income-Generating Assets
Below is an overview of some common income-producing investments.
Bonds generally form the foundation of income-seeking portfolios. That’s because they are essentially loans you give to governments, municipalities, corporations or other institutions that then pay you back with regular interest.
Different types of bonds and different features can affect a bond’s income, risk and return profiles. Learn about types of bonds and their income potential.
Dividend-paying stocks are shares of companies that distribute a portion of earnings to eligible shareholders. Stocks of companies with steady track records of paying dividends are attractive to income-seeking investors.
Larger, established companies with a history of profits are often the best dividend payers. You tend to find these dividend-paying stocks in the value-oriented areas of the equity market. Examples include utilities and consumer staples companies. Such businesses historically have been more likely to pay dividends than fast-growing companies in cyclical sectors, such as information technology.
What’s more, higher-quality, dividend-paying stocks can help keep your portfolio growing over time. How? Stocks of large, familiar companies historically have weathered the ups and downs of economic and market cycles better than smaller and growthier companies.
Real estate investment trusts (REITs)* are securities that trade like stocks on the major exchanges. They are essentially firms that own or finance income-producing real estate or related assets. REITs can own everything from office or apartment buildings to hotels to mortgages or loans, with many specializing in a single type of real estate, such as retail, residential or industrial.
Publicly traded REITs must distribute at least 90% of their taxable income as dividends, making REITs another popular investment for potential income. When rents rise, REITs’ dividends increase, which may help you stay ahead of inflation.
Moreover, while REITs are a subasset class of stocks, they typically do not move in lockstep with stocks or bonds, which may lower your portfolio's overall volatility.
On the other hand, economic downturns can negatively affect rental income and property values. REITs are subject to property market fluctuations, tenant demand and interest rate changes. (Interest rate increases generally don’t favor real estate.)
Some REIT products are more complex than others. You’ll want to research the different types of REIT investments and make decisions based on your overall investment goals.
Convertible bonds and convertible preferred stocks are called hybrid securities because they have characteristics of both bonds and common stock.
Each security type features periodic income: a coupon payment from convertible bonds and a dividend payment from convertible preferred stocks. Investors can convert each type of security into a fixed number of the issuing company’s common shares at a set price.
Thus, hybrid securities give you the opportunity to participate in a company’s equity price performance, collect income and reduce downside risk exposure.
Keep in mind that convertible preferred stocks do not guarantee investors will get their money back since these securities are perpetual. The lack of a guarantee makes convertible preferred stocks somewhat riskier than convertible bonds, which is why preferred stocks generally offer higher yields than convertible bonds.
Diversifying Your Income Portfolio
Diversification is crucial in income investing. By spreading your investments across different asset classes, you have the potential to reduce risk and enhance returns. Diversified income portfolios are designed to provide income from a range of income-producing investments.
Devising an Effective Income Investing Strategy
A portfolio needs more than income to effectively generate income over the long term—it also needs total return. (Total return is the rate of return of an investment that takes into account changes in its market price as well as the income it generated.) If total return falls below income, then income comes at the cost of diminishing capital. However, being overly focused on earning high returns generally leads to lower income and higher risk.
To achieve sustainable income, investors need to find the right balance between income and total return potential that aligns with their financial goals and risk tolerance. Here are three examples of how someone could approach an income portfolio:
Income-focused portfolios. Emphasize current income and capital preservation through allocations to fixed income and diversifying securities.
Balanced income portfolios. Seek a balance of current income, capital preservation and capital growth, primarily through allocations to fixed income but also by investing in equities.
Growth and income portfolios. Emphasize capital growth and current income through allocations to fixed-income and equity securities.
Understand the Tax Implications of Income Investing
Income from your investments, including dividends from stocks, interest from bonds and rental income from real estate, are subject to taxation. The tax treatment can vary depending on the type and source of the income.
For instance, qualified dividends may be taxed at a lower capital gains tax rate, while ordinary dividends are taxed at your regular income tax rate. Similarly, interest income from bonds is typically taxed as ordinary income, but certain bonds, like municipal bonds, can be exempt from federal taxes and sometimes even state taxes if you reside in the issuing state.
Rental income from real estate investments is also taxable, but you may be able to deduct certain expenses like property taxes, mortgage interest and maintenance costs, which might reduce your taxable income.
It's important to keep detailed records of all income and expenses associated with your investments to accurately report them on your tax return. Understanding the tax consequences can help you make informed decisions about your investment strategy and optimize your after-tax returns. Always consider consulting a tax professional to navigate the complexities of tax laws.
Professionally Managed Income Portfolios
Does building and managing an income-generating portfolio on your own seem daunting? Consider our multi-asset income solutions managed by professionals knowledgeable about the multiple risks investors face.
Based on your goals and risk tolerance, you can choose a portfolio aligned with the desired level of capital growth and preservation potential. Call us to find out more.**
Let’s Talk About Income
There is a lot to consider when choosing investments for income. We can help.
REITs may be subject to many of the same risks as a direct investment in real estate. These risks include changes in economic conditions, interest rates, property values, property tax increases, overbuilding and increased competition, environmental contamination, zoning and natural disasters. This is due to the fact that the value of the fund's investments may be affected by the value of the real estate owned by the companies in which it invests. To the extent the fund invests in companies that make loans to real estate companies, the fund also may be subject to interest rate risk and credit risk.
Private Client Group advisory services are provided by American Century Investments Private Client Group, Inc., a registered investment advisor. This service is generally for clients with a minimum $50,000 investment. Call us to determine the level of service that is appropriate for you. The advisory service provides discretionary investment management for a fee. All investing involves risk.
Diversification does not assure a profit nor does it protect against loss of principal.
As with all investments, there are risks of fluctuating prices, uncertainty of dividends, rates of return and yields. Current and future holdings are subject to market risk and will fluctuate in value.
Investments in fixed income securities are subject to the risks associated with debt securities including credit, price and interest rate risk.
Generally, as interest rates rise, the value of the bonds held in the fund will decline. The opposite is true when interest rates decline.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.
This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.