Living in our generation, if you want a shot at having enough money to live comfortably into old age, you need to be an investor.
They say the only two certainties in life are death and taxes, but you mind as well add inflation, too. On average, the cost of the stuff we buy goes up by 2 or 3 percent every year. If all of you money is sitting in a savings account that only earns 0.5 percent in interest, your hard-earned cash is disappearing right before your eyes.
This is why we invest: to earn a return on our principal that equals – and hopefully exceeds – the rate of inflation.
But investing is risky!
Yes, it is. An investment isn’t insured like a savings account; you stand the possibility of losing money. But investing doesn’t always have to be the aggressive, risk-loving gamble that’s depicted in stories about Wall Street.
Don’t get me wrong: it’s good to take risks, especially while you’re young and have decades ahead of you to invest. But if you’re been leery of beginning to invest, are more conservative by nature or your investing goals require a steady stream of payments rather than growth over many years, you may want to start learning about income investing.
As opposed to growth investing, in which you maximize gains and reinvest earnings to take advantage of compounding, income investing seeks to minimize losses while earning a modest but steady annual return.
Most often, retirees use income investing to earn money for retirement while protecting their principal.
Increasingly, income investing can be a valid long-term investing strategy for other circumstances. Let’s take a look at an investment in the stable, admittedly unglamorous company Johnson and Johnson (JNJ). It’s an established company this isn’t going to quintuple its profits (and stock price) in the next few years, but it pays a steady dividend – a percentage of its profits distributed to shareholders. If you bought $990 worth of Johnson and Johnson stock at the beginning of 1993 and reinvested the dividends, your investment would be worth over $11,000 or 11 times what you bought it for.
There are a number of ways you can invest for an income. The possibilities range from both equity-based investments to debt instruments and come with varying degrees of risk allowing you to customize your income strategy accordingly.
Mutual funds are perhaps the best place for new investors to begin. With the right mutual fund you get broad diversification and management so that your investing can be hands-off.
Mutual funds come in all shapes and sizes including funds built for dividends and income. Names like “equity income” or “dividend” are giveaways that these funds specialize in investing in large, high-quality companies that pay out their earnings in dividends rather than reinvesting it in the companies themselves.
One of the most common go-to investments for most people who think of income products are bonds. Bonds are debt instruments issued by companies or governments to finance projects or operations with the promise to repay the loan at a future date and pays interest on a monthly, quarterly, or semi-annual basis in return.
The attached interest rate for each bond is heavily tied to the credit quality of the issuer. They range in quality depending on the issuers’ creditworthiness from “AAA” down to “BBB” for investment grade bonds. Anything less than “BB” is considered to be a “junk” bond and speculative.
Master Limited Partnerships
Master Limited Partnerships (MLPs) are publicly traded companies that combine the tax advantages of partnerships with the liquidity of stocks. They are tied to natural resources like oil and gas and must generate 90 percent of their income from these sources. Because of their special tax treatment, they must pass most of their income on to shareholders and come with higher than average dividend yields. You can find a list of MLPs to invest in listed here.
While the majority of preferred stock is held by other corporations to take advantage of a tax loophole that favors income from corporate dividends, this asset class can work well for the income-oriented investor. Preferred stockholders have a higher claim on assets than common shareholders in the event of liquidation and must receive dividend payments prior to common stockholders getting any.
The downside is that preferred shares don’t come with voting rights like common shares and won’t get the kind of appreciation that common stock gets. The yields on preferred shares differ by company, but can be quite lucrative when compared to other sources like bonds and MLPs.
Preferred stock is a more advanced investment that you should fully understand before adding to your portfolio, but exchange-traded funds like the iShares S&P U.S. Preferred Stock Index (PFF) are a friendly way to begin.