Income investing – what strategies generate cash flow?

What is income investing?

Income investing involves purchasing assets that provide regular cash payments – i.e., income.

Such investments are popular because they provide steady income in addition to (hopefully) appreciating in value. Investors can treat the regular payments from these investments as regular income or can reinvest to take advantage of the power of compounding.

Important: This article is for general guidance purposes only and should not be considered investment advice. If you are unsure about the suitability of an investment, please seek out advice. When you invest, your capital is at risk. Tax treatment will depend on your individual circumstances and could potentially change in the future.

Who is income investing for?

Income investing is for anyone who wants additional income while they pursue a longer-term investing plan.

In particular, it may appeal to investors who have taken an extended time off work or those who have retired. You still need to generate income but want to do so without giving up on the potential returns a long-term investment can generate.

Additionally, if you’re investing in income-producing assets within a tax-efficient wrapper like a stocks & shares ISA, you won’t have to pay tax on the income generated by these investments (note that tax treatment will depend on your individual circumstances and could potentially change in the future).

Examples of income-producing investments

Dividend stocks

A dividend is a payment distributed to the shareholders of a company, usually taken from its profits. These payments are made periodically – often annually, quarterly, or monthly.

They are paid out on a per share basis, meaning the more shares you own, the more dividend payments you’re entitled to. Companies can – and do – suspend dividend payments during times of financial stress.

The annual dividend amount divided by the purchase price of the stock is called the dividend yield. A stock paying £0.20 in dividends annually that was bought for £20, for example, has a dividend yield of 1%.

To give you an idea of how much income you can earn through dividends Apple paid a quarterly dividend of $0.23 per share in Q4 2022, while Microsoft paid $0.68 per share and General Motors paid $0.09.

Dividend stocks that have a history of paying out are no doubt attractive for income investors, but it’s also worth noting that you may have to exchange some upside in returns when investing in them. One school of thought is that, if you have a long time horizon, you should consider growth stocks that reinvest capital into their operations rather than distributing to shareholders. Such stocks may have a higher ceiling in terms of overall returns, though they may also be more volatile.

Bonds

When you buy a bond, the issuer commits to paying a set amount of interest on its value at regular intervals. After a pre-determined period, the initial purchase value of the bond is paid back, and interest payments cease.

The periodic interest payment – called a coupon – represents the income portion of a bond. When people talk about “fixed-income” investing, they are often talking about investing in bonds.

The yield of a bond can be calculated by dividing its coupon payments by its purchase price.

Fund products

Putting all your investible cash into a single dividend-paying stock or bond in search of income means you’ll have no diversification in your portfolio.

Fortunately, there are funds (OEICs) and ETFs that have an income focus. These products will either actively purchase or track an index comprised of investments like the two mentioned above. This means you can be exposed to income-generating investments while also getting the benefits of diversification. You do, of course, have to pay additional fees to the provider of the fund, such as a management fee.

You can either receive the income generated by these funds as a periodic distribution or have it reinvested in the fund to take advantage of compounding. Many funds do the latter automatically.

Real estate investment trusts (REITs)

REITs are essentially companies that make real-estate investments. Shares of REITs trade on exchanges, meaning retail investors like you can gain exposure to real estate.

REITs’ investments often produce income. For example, if they own residential or commercial buildings, they’ll be collecting income in the form of rent, services, and lease payments.

This income can then be paid out to shareholders in the REIT periodically.

How can I get started investing for income?

1. As with any investment strategy, you shouldn’t just go into income investing blindly. Here are some considerations you may want to make before you put money to work:

2. Determine how much income you want to generate from these investments. This will help you identify potential assets to invest in.

3. Decide on a portfolio allocation. How much of your account do you want to be invested in income-producing assets? Remember, there’s an opportunity cost when it comes to portfolio construction. Are you sacrificing assets that could potentially appreciate more if you over-allocate to income investments?

4. Do your research. As with any investment, it’s important you know what to expect. For example, if you’re purchasing a stock you may want to look at its history of paying dividends. Has it ever cut the amount it’s paid out? Or even stopped paying the dividend entirely?

5. Make a decision what to do with your generated income. Will you use it to meet everyday expenses? Or will you look to reinvest it? If it’s the latter, then you may want to seek out investment products that do this automatically to maximise the impact compounding can have on your portfolio.

6. Monitor your investments and check in with your financial goals. Your chosen investment strategy may need to be tweaked as your circumstances change and your income needs are altered.

Capital at risk.