Portfolio income refers to the money generated from investments such as stocks, bonds, and real estate.
It should not be confused with earned income or employment-based earnings because it has the potential to grow over time even without active work participation.
This type of income can contribute significantly towards attaining financial stability and building wealth.
In this article, we will walk you through understanding portfolio income by discussing its sources and effective strategies for maximizing its benefits.
Portfolio income is the profit earned from investments such as stocks, bonds, and real estate.
This type of income mainly comes from interest on fixed-income investments like coupon bonds and dividends from stock holdings.
The advantage of portfolio income is its ability to provide financial stability without requiring constant effort unlike employment or business-related incomes.
By using effective investment strategies, one can steadily increase their portfolio income over time, which can lead offer early financial freedom and greater stability in retirement.
The regular monthly earnings produced by these investments can have a significant impact on psychological and financial well-being.
Stocks, Bonds, Real Estate (Directly held or in the form of REITs), Index Funds (ETFs) and Mutual funds may all provide portfolio income.
A Real Estate Investment Trust (REIT) is a business that invests in rental income producing properties.
Consumers like you and I can purchase the REIT in a brokerage account, and as a partial owner of the company, receive income payments in return for holding shares of the company.
Some of the most common Real Estate Investment Trusts include Public Storage (PSA), Realty Income (O), and Prologis (PLD).
Dividend-paying stocks pay dividend income to owners of the company.
Similar to a REIT, you can purchase shares in a company via a brokerage account (Retirement or Taxable account) and as a partial owner, receive dividend payments.
While we go into the tradeoffs of the different investment options in more detail below, it is important to know two things.
Bonds are interest paying loans to governments or companies.
The government (Federal, State, or Municipal) offers interest payments for a specified length of time in exchange for a loan to the public.
At the end of that specified length of time, your original investment is repaid to you, and you are allowed to keep all the interest income you were paid along the way.
An Exchange traded fund is similar to a REIT in that it is a single business entity that is a partial owner of many other business entities, typically in the form of stocks traded on a stock exchange.
When you purchase a share of an Exchange Traded Fund, you are a partial owner in that single business entity which owns MANY businesses.
As such, if that ETF holds many shares of dividend paying companies, you as a partial owner are entitled to a portion of those dividend payments.
There are whole categories of ETF's called Income funds whose primary investing objective is to produce investment income for their shareholders.
A Mutual fund is basically an Exchange Traded Fund that has an active manager who is compensated directly for their experience and expertise building a portfolio of companies owned by the mutual fund.
Again, as a consumer you purchase shares in the mutual fund which owns shares in many other companies, making you a partial owner of each of those companies.
If the Mutual Fund's investment objective is to produce income in the form of dividends owned by its portfolio companies, you as a partial owner will receive income payments as a partial owner.
Mutual Funds typically have higher fees to compensate for the fact that the fund is actively managed by a human being.
Choosing the appropriate investment among the options listed above requires skill, experience, and knowledge.
If you are interested in constructing an income generating portfolio with your saved assets, please consult with a fee only fiduciary financial advisor who has experience in this realm.
You can schedule a consultation with our fee only fiduciary team here.
1) As part of the trade off for the stream of income you receive as an owner of any of the above companies, the larger the income or dividend payment, the less capital appreciation you will likely see in the value of the company's shares.
2) Income paid for ownership of shares of a company or REIT may be taxed in various manners. It's important to understand the ways these income sources will be taxed when constructing an income portfolio.
Holding a blend of the above options can provide diversification protection, also known as capital preservation.
Diversification refers to spreading your portfolio asset allocation among many investment options so that if one investments value were to crater, only a small portion of your investment funds would be effected.
Diversification also allows you to benefit when particular investments perform better than others.
Were you to be too concentrated in one position, you might miss opportunities in other investments because you do not have a portion of your investment funds allocated to it.
While the goal of an income portfolio is to produce investment income without needing to contribute labor in exchange for those funds, it is not entirely true that this can be an entirely passive endeavor.
There is still risk involved in owning an income portfolio, and your job as the owner/manager of an income portfolio becomes risk management - making sure that you protect that income stream.
Portfolio income can be divided into two types: active income, also known as earned income, and passive income.
Active income involves a trade of labor hours for dollars (a job).
Passive income is money received from sources that require little effort to maintain, such as rental payments or royalties.
It is characterized by stability and longevity since these passive income sources typically continue generating revenue without much additional work once they are established.
Some financial experts classify portfolio income as a form of passive income due to its minimal activity requirement for sustainability. This helps differentiate it from active forms of earning (such as labor!), which involve more hands-on management and involvement in business operations.
Understanding the differences between various types of incomes like passive and active plays an important role in selecting suitable investments and strategies aligned with one’s financial goals.
Managing taxes for portfolio income can be complex, particularly in relation to capital gains.
A capital gain is the profit earned from selling an investment or asset at a higher price than its original cost and is subject to taxation under special capital gains tax rates. The profit is the capital gain.
Let's illustrate this with an example.
Say you buy 1 share of a stock for $10. You then sell it 6 months later for $14. The $4 profit is the capital gain which is subject to capital gains taxes.
Your original investment of $10 is NOT TAXED in this scenario. (There are exceptions to this, for example when investments are sold for a gain in a retirement account.)
Capital Gains tax rates are generally lower than income tax rates, and vary state to state.
In addition, capital gains tax rates are split between short and long term capital gains.
Finally, depending on the type of investment held, how long it has been held, the income stream may be taxed in it's own unique way.
It's important to understand the myriad of ways your portfolio will generate income that may be taxed in order to accurately estimate how much AFTER-TAX income you will actually produce with the portfolio.
Consult with a tax advisor or financial planner if you have an income portfolio but don't know the exact tax implications of the income it produces.
Click here to schedule a free consultation with our fee only fiduciary financial planning team.
Diversifying an income portfolio is crucial for managing risk and optimizing returns.
By spreading investments across various asset classes, industries, and companies, the impact of individual underperforming assets on the overall portfolio can be minimized while also taking advantage of multiple streams of income.
Significant research is involved to find stable companies that produce reliable, steady dividends without significant variability in the price of the company.
An 8% dividend yield is not necessarily a great investment if the underlying company depreciates by 20%!
So be careful to use the stated yield of the investment as the only criteria by which to evaluate the investment.
We like to look at the following criteria when evaluating an investments place in our income portfolios:
1) Tenure - how long it has been able to produce a reliable, predictable monthly income stream
2) Stability - how stable is the price of the underlying investment
3) Tax composition - how will the proceeds be taxed
4) Interest rate sensitivity - how sensitive is the underlying investment to changes in interest rate
5) Fundamentals - how fundamentally sound is the underlying business that we would be investing in.
Combining these 5 criteria with sound risk management strategies like diversification, reinvestment, and strategic rebalancing will result in a fundamentally sound income portfolio.
You can simulate a compounding effect with income producing investments by "reinvesting" dividends and income back into the initial investment.
Reinvesting offers various advantages such as easy setup and commission-free transactions, along with the ability to purchase fractional shares and quickly utilize available funds.
By consistently reinvesting income from their portfolio, individuals have a steady path towards accumulating wealth over time despite potential risks of lower returns if they are reinvested at a lesser rate.
To be clear - if you opt for reinvesting the income into the initial investment, you will be foregoing actually receiving the income generated!
You cannot do both at the same time, so it is important to align your reinvestment decision with your financial planning goals.
If you'd like to align your financial goals with a plan to help you achieve them, and would like to explore whether an income portfolio may be a part of that, schedule a free consultation with our fee only fiduciary financial planning team.
There are various avenues to generate portfolio income aside from the conventional options of stocks and bonds.
These include money market accounts as well as certificates of deposit (CDs), which present low-risk alternatives for earning income through investment.
Real estate or commodities have the potential to significantly increase a portfolio’s income by generating funds from sources such as rents and dividends, however these come with greater investment risk and risk management responsibility.
A money market account, offered by banks and credit unions, typically yields higher interest rates than other traditional savings account or accounts. It is a valuable component in generating portfolio income through regular interest earnings.
The interest rate offered on a money market account is variable and not under your direct control - as bank interest rates approach 0%, so too will money market account interest rates.
In contrast, Certificates of Deposit (CDs) are financial products intended for saving purposes.
They generate interest on a lump-sum deposit that remains untouched for a specific period.
Investing in CDs as part of one’s portfolio income strategy carries the risk of losing purchasing power over time due to inflation.
At the same time, you can "lock in" a guaranteed interest rate for a set period of time, which cannot be done with a traditional money market account or high yield savings account.
Limited partnerships offer investors the opportunity to contribute capital to a business entity while maintaining limited liability.
This can result in generating income or loss, which falls under the category of passive income.
Such earnings can be used to increase portfolio income or offset other sources of portfolio income, thereby increasing overall portfolio revenue.
Apart from limited partnerships, there are various alternative investments that also have the potential to generate additional streams of portfolio income including private equity, venture capital, hedge funds and commodities such as art and antiques.
Consult with a qualified financial planner before adding more complex alternative investments into your income portfolio.
Building an income portfolio can be a hugely rewarding experience.
It can provide long term, predictable, stable income to secure your financial future.
We recommend seeking out qualified financial advisors or financial planners (ideally both!) who can help you create a specific financial plan to help you reach your financial goals.
If an income portfolio is appropriate based on your financial plan, they can help you manage your portfolio income, as well as the investment selection and risk management associated with it.
You can view a series of guides including an Example Financial Plan, A Guide to the 3 Bucket Retirement Strategy, What is a Comprehensive Financial Plan, How are Financial Advisors Compensated.
Click here to schedule a free consultation with our fee only financial planning team to learn how we create unique and individualized financial plans.
Portfolio income is a valuable tool for attaining financial security and independence.
By utilizing a diverse investment approach that incorporates various assets such as stocks, bonds, ETFs, and alternative investments, individuals can generate a consistent stream of earnings that can greatly contribute to their long-term financial well-being.
With the assistance of professional advisors who understand one’s personal risk tolerance and financial goals, investors can customize their strategies in order to maximize profits and ultimately work towards achieving true fiscal freedom.
Portfolio income is a type of earnings that includes interest, dividends, and capital gains obtained from investments or loans made. This category does not encompass passive or earned income but may include royalties.
This form of revenue plays a significant role in one’s total earnings. It consists primarily of portfolio equity income, investment returns such as interest on bonds, stock dividends received by investors regularly (quarterly), and annual distributions resulting from portfolio investments.
Portfolio income and passive income are two types of earnings that differ in their source. Portfolio income is generated from stock dividends, interest earned on investments, and profits made from selling stocks. On the other hand, passive income comes from renting out property or receiving royalties for creative work as well as owning shares in limited partnerships.
There are three types of income: earned, portfolio, and passive.
Non-passive income is a small subset of passive income.
Income received from one’s portfolio is classified as passive for tax purposes and may be subject to a maximum tax rate of 20%. If an individual has incurred losses through passive activities, these can be used to offset any income generated from such activities.
Portfolio income is determined by dividing the investment amount for each asset by the total portfolio investment and then multiplying it with its respective weight. This will give you the individual incomes for each asset based on their returns.
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