A Guide to Income Investment Strategies - SmartAsset (2024)

An income investing strategy revolves around building a portfolio that generates a steady income. You might be interested in income investing if you’re looking for a way to build a supplemental income stream during your working years or for retirement. If you’re working with a financial advisor, an income strategy is one option you might be offered so it’s important to understand how this approach works.

What Is Income Investing?

Income investing is all about making investments that produce consistent income, either through dividends, interest or a combination of the two. So why would someone want to do that?

Simply speaking, income investing may appeal to people who need or want to increase their current income. The extra money generated by your incomes could be used to cover everyday expenses, pay off student loans or other debts or fund other financial goals, such as saving toward your child’s college expenses.

An income investing strategy is essentially the opposite of a capital appreciation strategy, which focuses on investing in companies that are poised to see significant growth over the long term. In this scenario, an investor is banking less on dividends and more on price appreciation by holding shares of companies that tend to reinvest retained earnings for expansion rather than paying them out to investors.

The overall goal of income investing is to provide an investor with passive income. Investors are less interested in stocks that may see big price jumps in years to come. Instead, they’re looking at companies that have a consistent track record of paying out dividends to their investors. So they may lean more toward the Dividend Aristocrats or Dividend Kings rather than trying to find the next Amazon or Facebook.

What Does an Income Investing Strategy Look Like?

There are different ways investors can approach income investing, in terms of what they invest in and how they manage their portfolios. For example, an income investing strategy can focus on stocks, but it can also include other securities, such as:

Each of these investments can produce consistent income with varying degrees of risk. For example, Treasury bonds are virtually risk-free since they’re backed by the full faith and credit of the United States government. But they may generate a lower rate of return compared to a REIT, dividend stock or dividend ETF.

Income investors may also look beyond traditional securities to include cash or cash equivalents in their portfolios. For example, they may invest in money market funds or keep a liquid reserve of cash in a money market account or certificate of deposit. These are relatively low risk but again, the trade-off can mean a lower rate of return and income.

Income Investing Strategy Examples

How you build your portfolio when investing for income can depend largely on your risk tolerance, time horizon and overall goals. The less risk you’re comfortable tolerating, for example, the more of your portfolio you may allocate to conservative investments. On the other hand, if you have a higher tolerance for risk then dividend stocks or ETFs may make up the bulk of your portfolio.

With that in mind, here are a few examples of what an income investing strategy might look like:

There are few rules to remember, however, when applying an income strategy. First, diversification still matters. While you could put 100% of your assets into bonds or real estate or stocks, you’re creating risk for yourself by doing so. An all-bond portfolio, for example, may fall short of your expectations in terms of the returns generated. An all-stock portfolio or all-real estate portfolio, on the other hand, could increase the possibility of losing money.

Diversifying and including a mix of income investments can help with managing risk and rewards. It’s also important to research individual investments. With bonds, for example, you should understand what type of bond you own, when that bond is set to mature and how much interest you’ll be able to collect over the maturity term. It’s also good to know how to interpret bond credit ratings to determine which bonds carry the highest or lowest degree of risk.

With dividend stocks, it’s helpful to understand the basics of how dividend yield and dividend payouts work to estimate what kind of income you could expect. And if you’re investing in ETFs, you’d want to look at the expense ratio so you know how much it’ll cost you to own the fund annually.

Pros and Cons of Income Investing

Income investing strategies may not be right for every investor and it’s important to weigh the advantages against any potential disadvantages. The main pro or benefit of income investing is that it’s generally less volatile than capital appreciation investing. A typical income investor holds bonds or invests in established companies so they’re more insulated against market swings that could cause substantial price drops.

On the other hand, income investing may carry more inflation risk for investors. When inflation creeps up and prices rise, purchasing power shrinks. Income investing can be problematic if the returns generated by your investments aren’t enough to keep pace with rising inflation.

The Bottom Line

Developing an income investing strategy could simplify your plans for growing wealth and creating passive income. Rather than actively trading stocks, you may be able to put the bulk of your portfolio on autopilot. Remember to weigh the potential inflation risk this type of strategy could present when considering whether it’s a good fit.

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