How to build your income investing strategy?

Do you need to build a portfolio that will generate cash? Are you concerned with paying your bills and having enough income now and need an additional income stream? If so, you should consider using an older investing technique—income investing.

What is income investing?

The art of good income investing is gathering a collection of assets such as stocks, bonds, mutual funds, and real estate that will generate the highest possible annual income at the lowest possible risk. Most of this income is paid out to the investor so they can use it in their everyday lives to buy clothes, pay bills, take vacations, and live a good life without worrying about money.

Naturally, income investing is popular with those at or nearing retirement. When you are retired, you depend on a steady flow of income to replace the income you once had when you were in the labor force. Today, with pension systems going the way of the dinosaur and 401(k) holders being spooked by fluctuating balances, there has been a resurgence of interest in income investing. In 2020, the amount of money being moved around in 401(k)s was the highest it has been since 2008.12

key investments for your income investing portfolio

When you build your income investing portfolio, you are going to have three major "buckets" of potential investments. These include:

First: Dividend-paying stocks

Both common stocks and preferred stocks are useful. Companies that pay dividends pay a portion of annual profit to shareholders based on the number of shares they own.

In your personal income investment portfolio, you'd want dividend stocks that have several characteristics.

1- Dividend payout ratio: You'd want a dividend payout ratio of 50% or less, with the rest going back into the company's business for future growth.

2- Dividend yield: If a business pays out too much of its profit, it can hurt the firm's competitive position. A dividend yield of between 2% and 6% is a healthy payout.6

3- Earnings: The company should have generated positive earnings with no losses for the past three years, at a minimum.

4- Ratios: Other considerations are a business's return on equity (also called ROE, after-tax profit compared to shareholder equity) and its debt-to-equity ratio. ROE and debt-to-equity should be healthy when compared to industry peers. This can provide a bigger cushion in a recession and help keep dividend checks flowing.

Second: Bonds

Bonds are often considered the cornerstone of income investing because they generally fluctuate much less than stocks. With a bond, you are lending money to the company or government that issues it. With a stock, you own a slice of the business. The potential profit from bonds is much more limited; however, in the event of bankruptcy, you have a better chance of recouping your investment.

Here are some bond characteristics you will want to avoid:

1- Lengthy bond duration: One of the biggest risks is something called bond duration. When putting together an income investing portfolio, you typically shouldn’t buy bonds that mature in more than eight years because they can lose a lot of value if interest rates move sharply.7

2- Risky foreign bonds: You should also consider avoiding foreign bonds because they pose some real risks unless you understand the fluctuating currency market.

Third: Real Estate

If you know what you’re doing, real estate can be a great investment for those who want to generate regular income. That’s especially true if you are looking for passive income that would fit into your income investing portfolio.

Your main choice is whether or not to buy a property outright or invest through a real estate investment trust (REIT). Both actions have their own advantages and disadvantages, but they can each have a place in a well-built investment portfolio.

This method is not without risk, and you shouldn't just put 100% of your investments into property. There are three issues with this approach:

1- If the real estate market falls, the loss is amplified by leverage, the use of debt to finance your real-estate purchases.

2- Real estate requires more work than stocks and bonds due to lawsuits, maintenance, taxes, insurance, and more.

3- On an inflation-adjusted basis, the long-term growth in stock values has always surpassed real estate.

Source: The Balance Money website