Income-producing assets — they almost sound too good to be true. Assets are valuable, but can they actually earn income for you? Like the income you earn at your day job?
The answer to both questions is YES.
People invest for one of two reasons. The first reason is growth. People want to grow their money for later. The second reason is to generate income now.
That second type of investor is an income investor. This investor seeks to build an investment portfolio of assets — bonds, dividend stocks, real estate, etc. — that generates income on a steady and recurring basis.
Perhaps this income source can supplement the income from your day job. Some investors use the income produced to reinvest in the stock market and go after additional growth, income, or a combination of the two.
Keep reading to learn more about passive income, the types of assets where you can find it, and how to differentiate between the best income-producing assets and the duds.
Income-Producing Assets: Not Only for Retirees
Although income investing can be associated with retired investors, it is appropriate for any investor.
Why is income investing usually associated with retirees? First, because retirees are understandably looking to generate income after they stop working. Second, financial advisors will recommend that as you get closer to retirement your risk profile should be getting more conservative, since many people are nearing the time where they’ll need to withdraw some of their savings.
But, income-producing stocks, bonds, and real estate can be the stable foundation of any portfolio — retiree or not. Because, at the end of the day, couldn’t we all benefit from some additional cash flow?
The Difference Between Income-Producing Assets and Growth Assets
Cash flow is a wonderful thing for obvious reasons, but it’s important to examine income investing vs. growth investing to truly understand all the benefits.
Sure, cash flow is great for financial freedom. But income-producing assets provide benefits way beyond freedom.
When building an investment portfolio for your future, there are two ways to enjoy the fruits of your labor. The first way is to sell investments that have appreciated. The second is to harvest the income from your assets and leave the actual asset alone so it can grow.
The most strategic investment strategies focus on minimizing the amount of assets you’ll need to sell or delaying those sales as long as possible, so those assets can continue growing and you can preserve and maximize intergenerational wealth.
The Upside to Passive Income
This income being generated by your investments is called passive income. Passive income is just what it sounds like. You invest upfront and then streams of income flow in while you essentially do nothing. Or while you take a ski vacation or a trip to the Caribbean. Not bad, right?
There is something magical about income with no actual work required. No hustle. No commuting. No overtime. No deadlines. When you own income-generating assets, it’s like having CEOs who make millions working for you and helping you build wealth.
Passive income plays by the same rules as other investments. To make money, you’ll need to assume risk. Looking for higher returns? You’re going to need to be comfortable taking on more risk.
For example, municipal bonds, certificates of deposit, money markets, and savings accounts will pay passive income and are considered low-risk. But the return on investment is next to nothing, especially in a low interest rate environment.
On the other hand, you could invest in a startup or innovative up-and-coming small business for a share of the company or the profits. On the slim chance the company survives and flourishes enough to pay you, the return has the potential to be significant. But you are very likely to lose the entire investment.
More risk generally means more return. The more risk you assume and the longer amount of time you can bear to be separated from your money, the higher payback you are likely to see if the investment is a successful one.
Types of Income-Producing Assets
Income-producing assets are assets that pay you while you own them. Of course, not all assets produce income. Think about an engagement ring or a home, for example. These are assets, but they don’t pay you income.
Now if you were to rent out part of your home to a tenant, now your home becomes an income-producing asset. Make sense?
There are many income-producing assets. Below are three common types.
Many public companies pay dividends and give their shareholders rights to vote and own a stake in the company.
Investing in dividend stocks is like “buying” future income. When you invest in a dividend stock, you receive a check in the mail — or more likely in today’s digital world, a deposit in your brokerage account — on a monthly or quarterly basis.
You earn income simply because you own shares of a company. The company sees it this way: You gave them some of your personal capital, and now they will share some of the profits with you.
And when you reinvest your dividends, you can purchase additional shares of stock with those dividend payments. By doing this, you accumulate even more dividend income earning power going forward through the principles of compounding.
Dividend stocks are hybrid investment vehicles because they provide the best of growth and income investing. Dividend stock investors are naturally less exposed to market volatility. This means less stress for you as an investor. Because you measure your portfolio’s success by the monthly income being generated instead of the stock price, you can withstand the ups and downs of the stock market with more peace of mind.
Think of it this way. When the stock’s market price tumbles, there is no problem because you’re still earning income. And if you’re reinvesting that dividend income, a lower stock price is actually a good thing. A lower stock price means you’re buying more shares of stock — and generating a better return on investment for your future.
The most consistent and reliable companies that pay dividends are called the Dividend Aristocrats. These are cash-generating companies with solid track records and market values above $3 billion. To qualify for the list, a Dividend Aristocrat must have increased their dividend payments for the last 25-plus consecutive years, despite market volatility.
The list of Dividend Aristocrats isn’t the only place to find dividend stocks for your portfolio. High dividend yields can generally be found in the stocks of banks, energy companies, utilities, and real estate investment trusts (REITs) as well.
The best dividend stocks can cover monthly expenses, grow faster than inflation, and usually have a more stable risk profile than growth stocks. As investors approach retirement, many will increase their position in dividend stocks.
Don’t want to spend time researching individual stocks that pay dividends? You’re not alone.
Dividend-focused funds are mutual funds, index funds, or exchange-traded funds (ETFs) that specialize in larger companies in more mature markets and equities that provide an aggregate yield that typically outperforms the market indexes. Often identified with the terms “dividend,” “income,” or “high yield” in the fund name, dividend-focused funds can invest in anything from dividend-paying stocks to real estate and corporate bonds
These funds can help mitigate risk because they enable more diversification by investing in income-oriented funds rather than one specific investment. The specific objectives of each fund will vary. It’s important to examine a fund’s holdings, objectives, and fees to determine whether the fund is right for you.
Real Estate Rental Properties
Rental properties and short-term rentals are quickly becoming one of the most popular options for those seeking to produce income from real-estate investing.
The benefits of investing in real estate properties are many. Rentals provide steady income, and real estate has historically appreciated over time. In addition, real estate can be quite tax-efficient since the investor has several options for avoiding or deferring taxable income.
Maybe you’re planning to purchase apartment buildings or a couple single-family homes with the sole intention of turning them into income-producing assets. Or maybe you’re thinking about buying a property that you can rent out through Airbnb from time to time.
Whatever your plan, make no mistake, generating rental income is in no way passive. The down payment alone can quickly eat into your cash reserves. Plus, to say that rental properties can be a headache is a massive understatement. They involve repairs, complaints from renters, vacancies, and delinquent payments.
Although it’s possible (and wise) to hire a property manager, doing so will significantly eat into your profitability. As a landlord, you’ll always be the one who is responsible for making decisions and repairs. Plus, you risk exposure when it comes to long-term vacancies.
What if you like the idea of investing in real estate but don’t want the hassle of being a landlord? Investing in real estate funds or REITs is a good alternative for investors seeking to earn income from real estate without doing the heavy lifting associated with traditional property ownership.
Building Wealth With Income-Producing Assets
Income-producing assets can create several streams of steady and reliable income for your future. By incorporating these assets into the overall investment plan, investors can achieve true diversification by avoiding overreliance on growth stocks and any one single investment.