If you are looking to make income by investing your money you are not alone. For the 73rd straight year, our savings account is earning an interest rate of zero. Yours are probably doing the same. The Federal Reserve has dropped the Federal Funds Rate to 0.25%, which in layman terms means that you aren’t getting paid much interest in your savings accounts. Fortunately, this also means that some of your loans may be charging less interest.
Over the last couple of weeks, I’ve been talking a good friend of mine who is a little older than me… kind of like a big sister. We think alike on many things. In some ways it is almost like talking to myself, but a “me” with ten years of more life experience.
Lately, we’ve been focusing on investments to create income. We’re both in a fortunate situation where income is steady despite COVID-19. Since we aren’t traveling, going to restaurants, or buying much gas for our cars our spending is way down. That leaves us with a little more money to invest than we’d normally have.
At the same time, the stock market continues to be near new highs. I’m worried that stocks are priced too high, especially when corporate profits are likely to be so low. Many, many people seem to be worried about that. For this reason, I’m looking for investments that tend to be safer. I’ll return to my usual growth investing when the pricing is better. In the meantime, I’ll continue to stay invested, but stay conservative.
Many people moving into their 30s and 40s find that they have more responsibilities (i.e. children). It makes sense to have investments that generate income. That income can be used to supplement your salary now or to help phase out your job in the future.
If you could generate $50,000 in cash from investments, you could probably retire, right? Of course, your answer depends on your spending, assumes no inflation, and has a bunch of other messy details.
So in this world of (close-to) zero interest rates, how do you generate income?
Income Investing: How to Generate Cash Now?
This is a refresh of an article from 2015. While I have been talking with my big sister about this topic again, I also participated in this this Twitter conversation with Financial Pilgrimage. Specifically, he asked, “Where can you invest your money passively these days for a 3% return or greater besides stocks?”
I don’t want to discount stocks because they are a viable option… perhaps the most viable option. Let’s start there and branch out.
Dividend Stocks for Income
For most of my investing life, I never looked at dividends. I forgot that people once bought stocks to create income. Companies would pay out profits to shareholders and shareholders could use that money, to… well… buy stuff they need. It was a good little system. I speak of it in the past tense because many companies stopped paying dividends and instead kept the money to grow profits and raise their stock prices. In reality, dividend investing didn’t go away, I was just too wrapped up in tech stocks (which rarely pay dividends) and index investing (set it and forget it) philosophies.
In 2020, I’ve focused more on dividends. I like the idea of companies paying me money even if the stock market is crashing. I’ve mentioned that I’m managing stock market risk and removing tech risk from my portfolio with dividends. Specifically, I’m buying iShare’s high dividend ETF (Symbol: HDV). It has many big companies that you’ve heard of. It also pays a dividend of more than 4%.
Another thing that I like about dividends is that they are very tax efficient. Qualified dividends can be taxed at 0% at reasonably high-income brackets (~$75,000 for joint filers). If you make less than $400,000 qualified dividends are taxed at 15% a year. (This is overly simplistic for the scope of this article. Please see your tax professional for more information and advice.)
Unfortunately, due to COVID-19, corporate profits have dropped. Some companies can no longer afford to pay the same dividends they did in the past. That’s why I like the ETF approach. It spreads that risk over a lot of companies.
If you want to take a more hands-on approach for potentially bigger gains, you could look at making passive income with dividend kings. If you prefer to get higher dividend gains without hours of research, I recommend Sure Dividend’s newsletter. That link to the newsletter has a special discount rate and in full disclosure, I make a few dollars if you sign up for it.
Find a Strategic Investment Balance
The credit for this idea goes to my aforementioned big sister. She had mentioned that she was looking at the Vanguard LifeStrategy Income Fund (Symbol: VASIX). It’s a conservative blend of 20% stocks and 80% bonds. Historically, it doesn’t go up or down a lot. Since it was created in 1994 it has had annual returns of 6.26%. It’s 1-yr, 3-yr, 5-yr, and 10-yr returns are all between 4.95% and 6.82%, which gives you an idea of how consistent it is. During the big stock market crash of 2008, it lost about 15% of its value. That’s very good when traditional stock investments lost 50% of their value.
This could be an option to park some medium-term money that you may use in 2-4 years. I’m interested in this because it achieves my goal of staying invested, while still providing some protection in the case of a big market crash.
Income from Real Estate Investment Trusts (REITS)
This is really a special case of the dividend stocks above. However, the profits are generated by real estate – which can move in a very different direction than the rest of the stock market. REITS are traded as stocks and have to pay 90% of its taxable income as dividends to shareholders. The end result is that you can earn 4-7% in dividends. However, like a stock, their value can go up and down.
My favorite way to buy REITS is with Vanguard Real Estate ETF (Symbol: VNQ). It’s easy one-stop shopping with a company, Vanguard, that I trust.
Getting Income from P2P Loans
In the past, I’ve recommended P2P loans. They haven’t worked out as well as I have expected. A few days ago the top P2P loan company, Lending Club, announced that it closing down its lending platform.
I had been steadily pulling my money out of Prosper and Lending Club for the past few years. Prosper is still around and it may be a good fit for getting a passive 3%+ return on your money.
Skip Income Investing: Pay Down Your Mortgage Instead
One of the readers of the Twitter thread mentioned an obvious way of getting 3% for many people… paying off a mortgage. That’s a guaranteed return on your money, which may be valuable to you.
I’ve been against this for years because I’ve always felt that I can make 8-10% by investing in the stock market. Over the long run that has worked out exactly as planned. However, his stock market feels different and I’m not sure what has happened in the past is going to continue for the next 10 years.
I’ve mentioned over the last few weeks that we are doing a 1031 exchange – selling one real estate property and buying another one. Because we formed a corporation, the bank is charging us a 4% interest rate. Not only that, but it readjusts every 5 years – it could be 7% or more in 2020. I didn’t know this when we went down the 1031 exchange path. Now, I’m much more interested in paying down this mortgage quickly.
The downside of paying down your mortgage is that you are effectively locking yourself into that 3% (or whatever your interest rate is) return for the long term. Also, in this case, you aren’t creating investment income. Instead, you are reducing debt, which, while different, can be effectively the same.
Get a High Interest Savings Account
Derek of Life and My Finances mentioned that Lake Michigan Credit Union has a 3% Max Checking account.
I didn’t like the requirements of direct deposit, 10 debit card purchases a month and 4 logins to their website. The direct deposit it a one-time change with your work, which hopefully isn’t too difficult. Derek mentioned that using services like Mint and Personal Capital count towards the logins. That leaves 10 debit card purchases a month. If you are still buying coffee shop or Starbucks each day, this may be easy.
For me, making the 10 debit card deposits would be difficult. I also know that I would forget or not be able to keep track of for several months of the year.
Final Thoughts on Income Investing
I think the best plan is to combine multiple of the above suggestions. A portfolio of 35% HDV, 35% VASIX, 10% VNQ should provide some long-term hopefully, safe gains. The remaining 20% of your money could be used to pay down a mortgage and invest in a high-interest savings account.
This wouldn’t survive a big market crash and still make 3%, however, it would probably not lose too much and put you in a position to make 5-6% most years.
This article was originally published on Mar 2, 2015 at 10:45
We started investing with bonds for the interest and moved on to stocks, MLPs, and Reits, all for the income they generate. Every stock we own, but one, pay a dividend. In fact, we didn’t buy Apple stock until it started paying a dividend. It has worked out well for us as this year our investment income has surpassed the amount we get from pension and social security. We have strict criteria for the company’s financial strength and safety rating, as well as their history of uninterrupted dividend payment, so I feel very safe with our selections.
The Digerati Life says
I want to be you when I grow up! :)
I like income generating assets because I don’t have to think about dipping into principal if I need that income. And why would I need that income, you say? Well, I use it to some extent for “rebalancing” purposes. It’s just additional ammunition for rechanneling funds into assets I decide I want to buy into at some point in the future, without triggering transaction costs. I also like the concept of buying assets where dividends grow over time, and all that generating more and more cash over time. Of course, it’s best to put the income generating assets in your retirement accounts, so as to avoid or defer taxes on the income.
You also mentioned quite a good number of income sources. I’d say each may serve a different purpose in your portfolio (beyond just the generation of income). I use bonds because they are not as well correlated to equities and so they’re in my portfolio to dampen volatility and lower risk.
Also, you mentioned your savings accounts returning 0%. Try online savings banks…some are returning at least 1%.
As always, great post!
Jay Rigler says
Another great article! This is exactly what I have been thinking about lately.
I have been using high-yield bonds to produce income in a separate part of my portfolio. But, one thing that has been missing from the income-side is the ability to rebalance. The COVID drop showed me that! I rebalanced my long-term investments on the way down and again on the way up, so now I have significantly more shares of all of my funds than I had before. But, I didn’t get to do that in my income portfolio because it’s all bonds and didn’t really have much performance separation by fund.
I had been looking at DVY by iShares, and now I’m also looking at HDV. Any thoughts on the differences?
Lazy Man says
Last year I lined up a bunch of the dividend ETFs and compared them. Unfortunately I don’t remember why I chose HDV over the others. The expense ratio on DVY seems to be 0.39% which may be it. HDV has an expense ratio of around .08%. DVY also has cigarette companies as top holdings, which isn’t my ideal investing philosophy. Then again HDV has oil companies in its top holdings, so it isn’t like my moral ground is too high here.
Jay Rigler says
Yeah, that expense ratio is out of bounds for me too.