What is Income Investing?

As an investment advisor, I am a big proponent of income investing. Many people shudder when they hear the words until I explain to them that it’s not as complex and intimidating as it sounds. Income investing is actually quite simple- it is a way to generate consistent cash flow from your liquid investments. By liquid investments I am referring to those investments that you have immediate access to and money that you could invest in a traditional investment portfolio (i.e. IRA, 401ks, Roth IRA, brokerage accounts).

Investment income comes from three places: dividends from stocks, interest from various types of bonds, and distributions that come from a variety of investments that do not fall exactly into the stock or bond category.

The Bucket System

I like to use the “Bucket System” to explain in easy terms where your liquid investments should go in order to generate the kind of income that you would like. There are four buckets:

1. Cash bucket- The cash bucket includes CDs and money markets. This is your emergency liquid cash fund- the money helps you sleep well at night. People often wonder exactly how much money that they need in this emergency fund. It will differ from person to person, and family to family. But my rule of thumb is to have six months of money in this bucket.

Expected yield in today’s environment? 0-1%

2. Income bucket- The income bucket includes a variety of bonds including government and municipal bonds, corporate bonds, and high yield or junk bonds. More niche areas include floating rate bonds and inflation protected bonds.

Expected yield in today’s environment? 0-7%

3. Growth bucket- The growth bucked will be filled US, international and emerging market stocks. Pure “growth” equities pay little or no dividends and are owned primarily for “capital appreciation.” Think of stocks like Google or Amazon – fast growing companies that chose not to pay out their profits in the form of dividends. Income producing stocks are also expected to have some level of capital appreciation, but have significant cash flow to go along with it – typically in the range of 2 to 5 percent. These stocks can show up in nearly any industry segment, but are most prominent in one of the following four industry sectors: consumer staples, healthcare, utilities, and telecommunications.

Expected yield in today’s environment? 2-5%

4. Alternative income bucket- The alternative income bucket includes investments that don’t quite fit neatly into the growth or income bucket. Examples include pipeline and energy storage companies, Closed End Funds, and master limited partnerships.

Expected yield in today’s environment? 4-8%

How Should My Money Be Divided Between the Buckets?

Each decade brings with it a different strategy for your investment income. Below I have outlined a basic strategy for income investing in your 40’s, 50’s and 60’s, accompanied by an explanation of the percentage of “income” you should expect in return. As with everything in life, there are no absolutes. But I have seen this strategy work time and time again.

At Age 40

Income bucket: 30% of your income goes in your income bucket. 100% of this bucket pays income, so you already 30% of your portfolio paying you income.

Growth bucket: 60% of your income goes in your growth bucket. 50% of this bucket should be dividend-paying stocks that pay income, which equals another 30% of your total portfolio paying you an income stream. Now we are at 60%.

Alternative income bucket: 10% of your income goes in your alternative income bucket. 100% of this bucket pays some sort of income, so your total portfolio is now paying you 70%.

At Age 50

Income bucket: 40% of your income goes in your income bucket. Again, 100% of this bucket pays income, so now you are at 40% of your portfolio paying you income.

Growth bucket: 50% of your income at this age goes in your growth bucket. 2/3 of this bucket is now paying you income.

Alternative income bucket: 10% of your income goes in your alternative income bucket. Same scenario, 100% of this bucket pays some sort of income. Now, in your 50’s, a whopping 83% of your portfolio is paying you income!

Read more: How Do I Generate More Income From My Investments?

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