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10 Steps to Successful
Income Investing for
Beginners
Income Investing Could Help You Pay the Bills
BY J OSH UA KENNON Updated January 27, 2020
Do you need to build a portfolio that will generate cash? Are you more
concerned with paying your bills and having enough income than growing
richer? If so, you should consider using an older investing technique—income
investing.
This long-lost practice used to be popular before the great twenty-year bull
market taught everyone to believe that the only good investment was one that
you bought for $10 and sold for $20. Although income investing went out of
style with the general public, the discipline is still quietly practiced throughout
the mahogany-paneled o ces of the most respected wealth management firms
in the world.
Income investing is the practice of designing a portfolio of diversified
investments to achieve a passive income to live on. These investments can
include real estate, stocks, mutual funds, and bonds. It is important to consider
which types of assets might be most valuable to someone who wanted to
follow an income investing philosophy and understand the most common
dangers that can a ect an income investing portfolio
01 Income Investing Defined
The art of good income investing is
putting together 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
JGI/Jamie Grill/Blend Images/Getty Images
bills, take vacations, or whatever else
they would like to do.
02 How the Social Unrest of the 20th Century Gave Birth
to Income Investing
Despite some nostalgia for the 19th and
early 20th centuries, society was quite
messy. The mess was not from the lack
of instant news, video chats, music-on-
demand, 24-hour stores, and cars that
could drive further than ten miles per
gallon.
Hy Peskin / Getty Images 
In that time-frame, if you were Jewish or
Irish, most companies wouldn't hire you.
If you were gay or lesbian, you were
prescribed electroshock therapy; black men and women dealt with the constant
threat of mob lynching and rape.
If you were a woman, you couldn't get a job doing anything more than typing, for
which you would be paid a fraction of the amount o ered to a man for similar
work. Add in the fact that there weren't any social security or company pension
plans, resulting in most elderly people living in abject poverty.
What does all this have to do with income investing? Everything. These are the
circumstances that caused the rise in income investing—when you peel back
the layers, it's not di cult to understand how.
The Rise of Income Investing
For everyone except for well-connected white men, the decent-paying labor
markets were e ectively closed. One notable exception: If you owned stocks
and bonds of companies such as Coca-Cola or PepsiCo, these investments had
no idea if you were black, white, male, female, young, elderly, educated,
employed, attractive, short, tall, thin, fat—it didn't matter.
You were sent dividends and interest throughout the year based on the total
size of your investment and how well the company did. That's why it became a
near-ironclad rule that once you had money, you saved it and the only
acceptable investing philosophy was income investing.
The idea of trading stocks would have been anathema (and nearly impossible
because commissions could run you as high as $200 or $300 per trade in the
1950s—the equivalent of $2,000 to $3,000 in 2020).
03 The Widow's Portfolio Bursts Onto the Scene
These social realities meant that women,
in particular, were regarded by society as
helpless without a man. Up until the
1980s, you would often hear people
discussing a portfolio designed for
income investing as a "widow's portfolio."
This was because it was a fairly routine
Jose Luis Pelaez Inc/Getty Images job for o cers in the trust department of
community banks to take the life
insurance money a widow received following her husband's death and put
together a collection of stocks, bonds, and other assets.
These investments would generate enough monthly income for her to pay the
bills, keep the house, and raise the children without a breadwinner in the home.
Her goal, in other words, was not to get rich but to do everything possible to
maintain a certain level of income that must be kept safe.
Today, we live in a world where women are just as likely to have a career as men,
possibly making more money. If your husband died in the 1950s, however, you
had almost no chance of replacing the full value of his income for your family.
That's why income investing was such an important discipline that every trust
o cer, bank employee, and stockbroker needed to understand. No one refers to
AT&T stocks as "a widow's stock" anymore, which should have been its second
name a generation or two ago.
Today, with pension systems going the way of the dinosaur, and wildly
fluctuating 401(k) balances plaguing most of the nation's working class, there
has been a resurgence of interest in income investing.
04 How Much Cash Should I Expect From an Income
Investing Portfolio?
The rule of thumb in income investing is
if you never want to run out of money,
you should take no more than 4% of your
balance out each year for income. This is
commonly referred to on Wall Street as
the 4% rule. This is because if the market
crashes, 5% has been shown in academic
research to cause you to run out of
shapecharge/Getty Images
money in as little as 20 years, whereas
3% did not.
Put another way, if you manage to save $350,000 by retirement at age 65
(which would only take $146 per month from the time you were 25 years old and
earning 7% per year), you should be able to make annual withdrawals of $14,000
without ever running out of money. That works out to a self-made pension fund
of roughly $1,166 per month pre-tax.
Multiple Income Stream Strategy
If you are an average, retired worker, in 2020 you will receive close to $1,500 per
month in social security benefits. A couple, both receiving social security
benefits, will average around $2,500. [1 ] Add a $1,166 per month withdrawal from
a pension fund, and you have a comfortable $3,666 per month income.
By the time you retire, you probably own your own home and have very little
debt, so absent any major medical emergencies, you should be able to meet
your basic needs. You could easily add another $500 to $600 per month to your
monthly income by doing some part-time work.
If you're willing to risk running out of money sooner, you can adjust your
withdrawal rate. If you doubled your withdrawal rate to 8% and your
investments earned 6% with 3% inflation, you would actually lose 5% of the
account value annually in real terms.
This would be exaggerated if the market collapsed and you were forced to sell
investments when stocks and bonds were low. Within 20 years, however, you
would only be able to withdraw $500 to $600 per month (roughly $300 to $400
in 2020 dollars).
05 What Types of Investments Should I Hold in an
Income Portfolio?
Digital tablet with graphs on table When you build your income investing
next to papers with financial data portfolio you are going to have three
major "buckets" of potential investments.
These include:
1. Dividend-Paying Stocks: Both
common stocks and preferred stocks
hocus-focus/Getty Images are useful. Companies that pay
dividends pay a portion of annual
profit to shareholders based on the number of shares they own. Try to
choose companies that have safe dividend payout ratios, which means
they distribute 40% to 50% of their annual profit and reinvest the
remainder back into the business for growth. A dividend yield of 4% to 6%
has generally been considered good for some time.
2. Bonds: You have many choices when it comes to bonds. You can own
government bonds, agency bonds, municipal bonds, savings bonds, or
others. Whether you buy corporate or municipal bonds depends on your
personal taxable equivalent yield. You shouldn't buy bonds with
maturities of longer than 5 to 8 years because you face duration risk—the
risk of bonds fluctuating wildly like stocks in response to changes in the
Federal Reserve controlled interest rates.
3. Real Estate: You can own rental properties outright or invest through real
estate investment trusts (REITs). Real estate has its own tax rules, and
some people are more comfortable because real estate o ers some
protection against high inflation. Many income investment portfolios have
a heavy real estate component because its tangible nature creates
lasting value. Psychologically, this provides a needed peace of mind to
stick to a financial plan during fluctuating markets.
A closer look at each category can give you a better idea of appropriate
investments for income investing portfolios.
06 What to Look for in Dividend Stocks for an Income
Investing Portfolio
Dividend stocks income investing In your personal income investment
portfolio, you'd want dividend stocks that
have several characteristics. You'd want a
dividend payout ratio of 50% or less, with
the rest going back into the company's
business for future growth.
If a business pays out too much of its
profit, it can hurt the firm's competitive
Getty Images
position. A dividend yield of between
2% and 6% is a healthy payout. That
means if a company has a $30 stock price, it pays annual cash dividends of
between $0.60 and $1.80 per share.
The company should have generated positive earnings with no losses for the
past three years, at a minimum. Income investing is about protecting and
providing income, not swinging hard to hit the ball out of the park with risky
stock picks.
Company History and Financial Performance
A proven track record of (slowly) increasing dividends is also preferred. If
management is shareholder-friendly, it will be more interested in returning
excess cash to stockholders than expanding the empire, especially in mature
businesses that don't have a lot of room to grow.
Other considerations are a business's return on equity (ROE—after-tax profit
compared to shareholder equity), and its debt-to-equity ratio. Debt-to-equity is
determined by dividing shareholder's equity by the amount of total debt a
company has, revealing its ability to pay its obligations.
If a company can earn high returns on equity with a manageable debt-to-equity
ratio (for its industry), it generally has a better-than-average financial model for
income investors. This can provide a bigger cushion in a recession and help keep
dividend checks flowing.
07 What Allocation Should I Consider for My Income
Investing Portfolio?
Man sitting in chair trading stocks What percentage of your income
in front of six computer screens investing portfolio should be divided
with data and graphs among these asset classes (stocks,
bonds, real estate, etc.)? The answer
comes down to your personal choices,
preferences, risk tolerance, and whether
or not you can tolerate a lot of volatility.
Asset allocation is a personal preference.
Tetra Images/Getty Images
The simplest income investing allocation
would be:
• 1/3 of assets in dividend-paying stocks that meet previously stated
criteria
• 1/3 of assets in bonds and/or bond funds that meet previously stated
criteria
• 1/3 of assets in real estate, most likely in the form of direct property
ownership through a limited liability company or other legal structure. You
could use this portion of your portfolio as a 50% down payment and
borrow the rest so you can own double the real estate.
A Look at the Numbers in Detail
What would this allocation look like in a real portfolio? Let's take a look at a
worker who retires with $350,000—again, this would only take $146 per month
at 7% between the ages of 25 and 65. To keep the numbers simple, round up to
the nearest $5 increment:
• Stocks: $108,335 invested in high-quality dividend stocks that have an
average yield of 4.5%. Expected annual income: $4,875
• Bonds: $108,335 invested in high-quality bonds that have an average
yield of 4.5%. Expected annual income: $4,875
• Real Estate: $108,335 used as 50% equity combined with another
$108,335 borrowed from the bank to buy a total of $216,670 in property.
After expenses, maintenance, costs, and vacancies, the expected annual
income is $15,100.
• Grand Total Pre-Tax Income: $24,850 in cash. For sustainable income
money, however, you should only take out 4% of the $350,000, or
$14,000, so you would leave $10,850 in your income investing portfolio
(an accounting professional should be consulted for tax consequences).
08 Bonds in an Income Investing Portfolio
Online investment keyboard 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
Peter Dazeley/Getty Images from bonds is much more limited; however, in
the event of bankruptcy, you have a better
chance of recouping your investment.
This is not to say that bonds are without risk. In fact, bonds have a unique set of
risks for income investors. Your choices include bonds such as municipal bonds
that o er tax advantages. A better choice may be bond funds, which are a
basket of bonds, with money pooled from di erent investors—much like a
mutual fund.
Bond Characteristics to Avoid
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 5-8 years because they can lose a lot of value if interest
rates move sharply.
You should also consider avoiding foreign bonds because they pose some real
risks unless you understand the fluctuating currency market.
If you are trying to figure out the percentage your portfolio should have in
bonds, you can follow the age-old rule—which, according to Burton Malkiel,
famed author of A Random Walk Down Wall Street and respected Ivy League
educator, is your age. If you're 30, then 30% of your portfolio should be in bonds.
If you're 60, then 60% should be.
09 How Real Estate Might Help You Double the
Withdrawal Rate
Man standing in field admiring If you know what you’re doing, real
imaginary house estate can be a great investment for
those who want to generate regular
income (picture payments rolling in each
month). That’s especially true if you are
looking for passive income that would fit
into your income investing portfolio.
Thomas Jackson/Stone/Getty Images Your main choice is whether or not to buy
a property outright or invest through a
REIT. Both actions have their own advantages and disadvantages, but they can
each have a place in a well-built investment portfolio.
A Major Advantage of Real Estate
One major advantage of real estate is that if you are comfortable using debt, you
can drastically increase your withdrawal rate because the property itself will
keep pace with inflation. This method is not without risk.
If you know your local market, can value a house, and have other income, cash
savings, and reserves, you might be able to e ectively double the amount of
monthly income you could generate.
Why You Shouldn't Go All-In
If real estate o ers higher returns for income investing, why not just put 100%
of your investments into property?
This question is often asked when people see that they can double, or even
triple the monthly cash flow they earn when buying property instead of stocks
or bonds. 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 beat real estate.
10 The Role of Saving in an Income Investing Portfolio
Jar of coins tipped over spilling Remember that saving money and
on table investing money are di erent. Even if you
have a broadly diversified income
investing portfolio that generates lots of
cash each month, it is vital that you have
enough savings on hand in risk-free FDIC
insured bank accounts in case of an
emergency.
Deborah Pendell/Getty Images
The amount of cash you require is going
to depend on the total fixed payments
you have, your debt levels, your health, and your liquidity outlook (how fast you
might need to turn assets into cash).
Understanding the value of cash in a savings account cannot be overstressed.
You should wait to begin investing until you have built up enough savings to
allow you be comfortable about emergencies, health insurance, and expenses.
Only then should investing be conducted.
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