Income Investing—Not Just for Retirement Anymore
Think investing for income is just for funding retirement? Think again.
Discover how dividend stocks, bonds, real estate investment trusts (REITs) and convertible securities may boost your cash flow and support your financial goals throughout life.
Investing isn’t just about seeking to grow your money—it can also help create multiple streams of income. And while investing for income is commonly thought of as a retirement strategy, it can be useful at any stage of life for a variety of goals.
An income investing strategy can help:
Pay for planned expenses like education or home repairs
Supplement your paycheck and living expenses
Fund a big purchase, like a home
Build up an emergency fund
Let’s walk through the essentials of income investing, the types of investments that generate income and key components of crafting an income investing strategy.
How Is Income Investing Different From Other Investment Strategies?
An income investment portfolio focuses on investing in assets that provide ongoing payments while you own them, rather than solely on capital appreciation potential. This means you might give up some return potential for the opportunity to receive cash you can use now.
Here’s a closer look at how four of the most common income-producing securities work.
- Interest from bonds
- Dividends from stocks
- Rent-like payouts from real estate investments
- Payments from convertible securities
How Bonds Generate Income for Investors
Fixed-income investments generally form the foundation of income-seeking portfolios. They are essentially loans you give to governments, municipalities, corporations or other institutions. In return, you typically receive regular interest payments until the bond matures, at which point you get your initial investment back (unless default occurs).
Different bond types and features can affect a bond’s income, risk and return profiles. Learn more about the different kinds of bonds you can invest in.
How Dividend-Paying Stocks Generate Income for Investors
Dividend stocks are shares of companies that make payments (typically quarterly) to shareholders. Larger, established companies with more predictable profits are often regarded as the most reliable dividend payers. You tend to find these stocks in the value-oriented areas of the equity market. Examples include utility and consumer staples companies. Fast-growing companies, like many technology companies, typically need to reinvest earnings in the business rather than pay dividends.
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 those of smaller and growth-oriented companies.
How REITs Generate Income for Investors
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 a 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, REITs are subject to property market fluctuations, tenant demand and interest rate changes (interest rate increases generally don’t favor real estate). Of course, economic downturns can negatively affect rental income and property values.
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.
How Convertible Securities Generate Income for Investors
Convertible securities are often called hybrid securities because they have characteristics of both bonds and common stocks. Investors find them attractive because they give the potential to collect income, participate in a company’s equity price performance, and reduce downside risk exposure. In most cases, the holder of the convertible security determines whether and when to convert. In other cases, the company has the right to determine when the conversion occurs.
Convertible bonds, which provide an ongoing stream of coupon payments, can be converted into a preset number of shares of the company's common stock. If the convertible bond is not converted into common stock, it will mature on its maturity date when the issuer is scheduled to repay the principal amount to investors (unless default occurs). As a fixed-income security, convertible bonds are exposed to the same risks as traditional corporate bonds, including default risk, credit risk and interest-rate risk.
Convertible preferred stocks pay a dividend, usually quarterly, and give investors the opportunity to convert the security to a set number of shares of the underlying common stock. Although it does not have a maturity date, it may allow the company to redeem the issue at a stated value.
Keep in mind that there is no guarantee investors will get their money back with convertible securities. And their value is determined by multiple factors, including the performance of the underlying stock. Every security is constructed differently, and it’s important to research the specific convertible securities you’re interested in.
How Do You Build an Income Portfolio?
Income-generating assets vary not only in their average yield but also in income consistency. In other words, the amount of income can fluctuate in response to risk and changing market and economic conditions.
Here are three tips for building an income portfolio.
1. Don’t Overlook the Value of Diversification
Diversification matters in an income portfolio because it mitigates the risk that you’re relying too heavily on one source of income.
A variety of income-generating assets can help create a steadier income stream as well as give you the potential to reduce risk and enhance returns. For example, when stocks perform poorly, bonds might still pay reliably.
2. Match Your Income Investing Strategy to Your Goals
A portfolio needs more than yield 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 generates.) If total return falls below income, then income comes at the cost of diminishing capital.
However, being hyperfocused on total return might lead to more overall wealth but also lower and less reliable income, higher risk and overall volatility than a pure income strategy.
Investors need to decide the levels of income and total return potential that align with their financial goals.
High-yielding investments typically offer immediate cash flow but can limit upside, while growth investments may pay little income but provide the opportunity for capital gains. Here are three ways an investor could approach the trade-off between income and growth.
Income-first portfolios emphasize current income and capital preservation. This generally results in higher bond allocations and some stocks with an established track record of paying dividends.
Balanced income portfolios seek a balance of current income, capital preservation and capital appreciation potential. An asset allocation of 60% stocks and 40% bonds is widely considered a “balanced” portfolio because it’s historically shown to offer an attractive mix of growth-oriented and dividend-paying stocks along with the capital preservation and steady income potential of bonds.
Growth and income portfolios tend to lean more toward capital growth over current income for investors who are less reliant on investment income. That’s why growth and income portfolios generally have a larger percentage of stocks than traditional balanced portfolios.
The best approach depends on an investor's goals, cash flow needs, time horizon and risk tolerance.
3. Understand How Investment Income Is Taxed
Staying up to date on tax rules can help you keep more of what you earn after taxes. Income investments are taxed differently depending on their source of income.
Ordinary interest income (like bond interest) is taxed at your regular income tax rate.
Qualified dividends may be taxed at more favorable capital gains rates.
Municipal bond interest may be tax-free at the federal and state level.
Rental income from real estate investments is also taxable, but you may be able to deduct certain operating expenses like property taxes, mortgage interest, and maintenance and depreciation costs, which might reduce your rental 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. Learning more about the ins and outs of combating taxes may help boost your after-tax returns.
Always consider consulting a tax professional to navigate the complexities of tax laws for your specific situation.
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Professionally Managed Income Portfolios
If building and managing an income-generating portfolio on your own seems daunting, consider professionally managed solutions that do it for you. You can choose a portfolio aligned with your desired levels of income, capital growth and capital preservation potential, based on your goals and risk tolerance.
Call us to find out more about our income solutions.
Income Investing Is More Than a Retirement Strategy
Investing for income isn’t only for retirees—it’s a strategy that all investors can use to supplement income, balance risk and help build long-term wealth. By understanding key income-producing assets, diversifying wisely and staying aware of taxes and market changes, you have the opportunity to build a resilient income portfolio that can be a smart part of your financial plan.
Let’s Talk About Income
Looking for a yield-focused portfolio that also seeks to manage downside risk?
American Century's advisory services are provided by American Century Investments Private Client Group, Inc., a registered investment advisor. These advisory services provide discretionary investment management for a fee. The amount of the fee and how it is charged depend on the advisory service you select. American Century’s financial consultants do not receive a portion or a range of the advisory fee paid. Contact us to learn more about the different advisory services. All investing involves the risk of losing money.
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.
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.
REITs funds 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.
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.