Income investing is a style of investing that prioritizes assets that have significant cash flow. This means that your investments will provide you with something like a paycheck that you can use to support your life’s expenses.
I believe that everyone interested in early retirement should be an income investor. It’s simply the fastest way to replace the income of a full time job.
The Primary Goal of Income Investing
The idea behind income investing is to buy assets that will pay you in a similar way that a full time job would pay you. Your investments put money in your bank account at regular intervals and can support the normal expenses of living your life.
A traditional investor plans to sell off assets in order to make the money they need to live. If you end up living off your retirement account, you’ll likely end up having to sell off some of those stocks every year in order to survive.
An income investor (I also call them cash flow investors) accumulates investments that never need to be sold to support their lives.
With the right portfolio of investments, you don’t have to be a millionaire to quit your job. In fact, I believe it’s more than possible to create a $100,000 income from less than $500,000 worth of investments.
Types of Income Investments
All these investments that can create cash flow for their owners.
1. Stocks (dividends)
The most common form of investing is buying stocks. It just so happens that lots of companies make regular dividend payments to their stockholders. Dividends are typically paid out either twice or four times per year.
Dividends are often paid by long established companies that have solidified their position in the market. Companies like Microsoft pay dividends to their investors, but these types of companies will typically only pay dividends of 1-4% of the value of the stock.
In order to earn a $100,000 income from these types of dividends, you’d need a minimum of $2.5 million invested. And it would likely require closer to $5 million.
There are, however companies that pay dividends of higher than 4%. The trick is that these companies are rarely established and in order to sustain dividends above 4-5% you’d have to be more active and knowledgeable. It is possible to maintain dividends at this level, but quite difficult.
If you’ve read this blog much, then you know I’m not a stock investor. I’m not a stock expert. I did open an investing account for my daughter and bought some dividend stocks for her, but my area of expertise is real estate and business.
I believe there is a better way, but first…
2. Index and ETF funds
Index funds and ETFs are probably the easiest way for stock investors to majorly diversify their stock portfolios. When you buy a share of one of these funds, you are purchasing part ownership of a large portfolio of stocks.
For example, the S&P 500 is an index fund that owns the 500 largest companies traded in the U.S. stock market. If you purchase one share of the S&P 500, the value of that one share is representative of the value of all 500 companies.
The draw of these funds is you don’t have to be an expert to make money. In fact it’s been shown that index funds have better returns than actively managed funds. So even if you are an expert, you might be better off investing in index funds and ETFs.
And many of these funds will have ownership in companies that pay dividends, which means your shares will pay you dividends as well.
And there are even ETFs with dividends as a specific focus.
3. Real estate (long term rentals)
Real estate is a huge part of my income investing strategy. I’ve shown before that long term rentals can result in a 27% ROI over long periods of time.
With long term rental real estate investing, you rent a property you own to someone else. The rent you receive will pay for the home’s mortgage and expenses and there can still be money left over to put in your pocket.
For example you may have a duplex that you charge $600 per month to live in one side. If your mortgage is $600 per month and your average monthly expenses are $400 per month, then you’ll still be making $200 per month after all those expenses. That’s the basic formula for income investing with real estate.
Investing in real estate has advantages well beyond the income they provide, including appreciation of the property, payment of the mortgage and tax deductions. That’s why we can see returns as high as 30% on these investments.
4. Real estate (short term rentals)
I wanted to separate out the two types of real estate investment that I partake in. Long term rentals are familiar to most because most have rented a home at some point in their lives.
But platforms like Airbnb, HomeAway and VRBO are allowing real estate investors to create better income than they were making with long term rentals.
Kate and I are making over $60,000 in pure income from three properties we have listed on Airbnb and VRBO. We do this by allowing travelers to stay in our homes for a few nights at a time and charging around $100 per night. Where we might make $800 per month with a long term rental, we’re now making $2,000 per month with short term rentals.
I can’t say that this strategy will work for everyone as well as it’s worked for Kate and me, but there’s no doubt that short term rentals can create serious income for investors.
I’ve spent the last 6 months studying and preparing to acquire an online business. Why? Because businesses can create more cash flow, more income, for your money. You can typically buy a business for 2-3 times their yearly profit.
Think about that.
A competent investor can pay $100,000 for a business and have that $100,000 back in their bank account in 2-3 years AND STILL own a business making $50,000 per year.
Business acquisition is a strategy that allows investors/entrepreneurs to skip the difficult startup phase of a company and simply purchase an already profitable business.
I also want to quickly mention that businesses also offer several tax benefits that your full time job does not. All these things add up to the potential for 30% return on investment on business purchases.
I believe stocks, real estate and business are the best ways to create income from your investments, but they’re definitely not the only way.
Bonds are just loans that you, the investor, give to more reliable borrowers (like large companies or the government). When you purchase a bond, you are giving your money to one of these borrowers.
You get interest payments on this loan for the duration of the bond, and when the bond expires, you get your initial investment back.
There are two primary reasons I hate bonds as an income investment:
- The returns are usually lower than the rate of inflation
- The returns are not compounding
Long story short, it’s nearly impossible for the average investor to get rich with bonds.
There are other ways to become a lender. Websites like LendingTree.com allow regular people to lend their money to others and earn a return on their investment. And you can always go outside the institutions to lend your money to others.
This type of investing has many of the same downfalls as bonds. The ROI is usually higher (4-6%), but again you won’t get the benefits of compounding interest.
I steer clear of this style of income investing.
8. High yield savings accounts
There are also various types of accounts where you can store your money in exchange for a small interest rate. We run into the same problems again here, though.
The best return rates on high yield savings accounts are currently less than 1%. The only upside here is that these accounts do leverage the power of compound interest.
For me, I don’t consider anything that can’t beat inflation to be an investment. No high yield savings accounts for me.
How Much $$$ Can You Make?
OK, so now you know most of the major types of income investments, and you know that stocks, real estate and business offer the best returns. But how much income can you really create from this style of investing?
You can create A LOT of income from these investments.
In fact, Kate and I have created over $50,000 in yearly income from our investments in less than three years. And we expect to create another $150,000 in yearly income over the next three years.
Analyze investments with cash on cash return
Before looking at return potential, we need to figure out how to measure the amount of income produced by various types of investments.
I use a metric called cash on cash return. It is a way to measure how much income you produce from an investment and how fast your initial investment is returned to your bank account.
For example a 100% cash on cash return means that after 1 year, your entire initial investment was returned to you. If you put $100 into stocks and after 1 year you had $100 in dividend payments and you still own the stocks, you had a 100% cash on cash return.
In general a 20% cash on cash return is excellent, it’s the metric I use when analyzing an investment. It means it will take about 5 years to return my initial investment. Let me show two examples.
A quick cash on cash return example
I pay $1,000 for a website. Each month, I make $25 from advertisements, so after 12 months I will have made $300 total.
That means I made back 30% of my initial $1,000 investment, or in other words, a cash on cash return of 30%.
If I continue to make $25 per month, after three years, I will have made $900, and four months later I will have made back my entire $1,000 initial investment (plus I still own a website making $25 per month).
A quick cash on cash example with debt
Let’s say I purchased that same website for $1,000, but this time I put in $500 of my own money and took out a loan for $500. Assume the loan payments are $10 per month.
Instead of making $25 per month, I’ll be making $15 per month ($25 – $10 loan payment).
That means after 1 year, I will have made $180 (12 months x $15). But since my initial investment was actually $500, I actually made back 36% of my initial investment.
After 3 years I will have made $540, more than my initial investment!
We’ll come back to the concept of using debt in a bit.
Investments ranked by return
I’ve written before about the return potential for various investments. Here’s a quick summary:
|Type||Potential ROI||Potential Cash on Cash|
|Real Estate (long term)||25%||25%|
|Real Estate (short term)||30%||40%|
|High Yield Savings||1%||1%|
There’s nuance to these numbers. The potential ROI is a LONG TERM return on investment, which means your investment can be expected to get that amount of return each year over a long period of time. The cash on cash is a ONE YEAR return on investment. This means it’s the ROI after one year.
Here’s what you should take from this table.
Investments that have higher potential ROI are better long term investments, and those that have higher potential cash on cash return are better income generating investments.
Using debt to amplify income
Some of these investments have ridiculously high return potential. Think about this. If you put $10,000 into stocks when you were 30 years old and got a 30% ROI, when you turned 50 those stocks would be worth $1.9 million.
The most powerful force of these kinds of returns is debt. I’ll try to demonstrate this with a simple example.
Example of the power of debt
It’s possible to buy an investment property with a 15% down payment. Let’s assume you had $15,000 to invest and you were able to buy a property worth $100,000.
You put in $15,000 and the bank gives you a loan for the remaining $85,000.
One characteristic of property is that it gets more valuable over time. On average, property increases in value by about 4% each year.
So after 1 year your property would be worth $104,000.
But guess what?
Your loan from the bank didn’t change in size, which means that extra $4,000 is all yours. You put in $15,000 of your own money and a year later you’re $4,000 richer simply because the house is worth more.
That’s a 27% return on investment on your $15,000!!!
Debt is a tool that can turn a 4% ROI into a 27% ROI. But you should also know that debt can turn a -4% ROI into a -27% ROI. It amplifies your successes and your failures.
Debt is a good segue into the topic of risk. I’ve got an entire article discussing the various types of risk your see in investing.
Here’s the list I came up with:
- Inflation risk
- Debt risk
- Legal risk
- Tax risk
- Ignorance risk
- Timing risk
- Holding risk
An investment like business or real estate will have risks like debt risk, ignorance risk and legal risk. Anytime you take on a loan to invest, there’s going to be a risk with not being able to make the payments. And the higher return investments require more knowledge to be successful, so ignorance can lead to costly mistakes.
Investments like bonds and savings accounts have serious inflation risks. Your investments may grow slower than the cost of living, thus you’re actually getting poorer even though you’re investing.
Stocks have timing risks. This means that you may get worse returns simply because of when you’re investing. And sometimes those periods of bad returns are completely outside your control.
Fixed income vs. variable income
Another quick topic I wanted to discuss is the variability of income based on your investments.
All of the higher income investments (stocks, real estate and business) have uncertainty in terms of how much income you make from year to year. One year you make $60,000 from your investments and the next you might make $35,000.
But some of the lower income investments like bonds and savings accounts have set interest rates. That means if you made $60,000 last year you know you’ll be making at least $60,000 again this year.
There are obviously risks associated with not knowing exactly how much money you’ll be making from year to year. If you don’t plan properly you could end up having trouble paying your expenses.
My Personal Income Investing Approach
I invest for income. I’ve been doing it for three years now and I’ve had a decent amount of success so far (Kate has since quit her full time job).
When Kate and I started investing we didn’t have much direction. We had heard a lot of people say that real estate was a great way to create wealth, so we were trying to invest in real estate.
Now we have some experience and we’ve begun to formulate an investment strategy.
1. Prioritize real estate and business
First, we are investing in real estate and business until we reach a point where our investments allow us to quit our jobs. We focus on these two types of investments because they provide the most income for your money.
You can reach significant levels of income in a matter of 5 years or less.
We’ve created over $40,000 of largely tax-free income in about 3 years by investing in real estate.
Now we’re looking to create another $100,000-150,000 in income over the next 3 years by investing more in business.
At that point I’ll quit my job and we’ll be living off our investments.
2. Start allocating some of your money to stocks
After quitting my job, I still intend to invest heavily. But instead of putting all our money into real estate and business, we’ll begin to invest some into dividend stocks.
Once you accumulate wealth, your focus should start to shift from growing as fast as possible to mitigating risk. By investing more into stocks we’ll be diversifying our income streams and lower the impact of any one investment losing money.
3. Three significant income streams
Over time we want to create three big income streams. One from real estate, one from business and one from the stock market.
We want the income from each of those three streams to be capable of supporting our lives. That way if any one (or two) of those streams disappears, our lives will be minimally impacted.
Income investing (or cash flow) investing is all about purchasing assets that provide you with income. That means you can put money in your bank account without ever having to sell anything.
There are three great investments to create income:
- Real estate
- Stock market
All three can create income capable of sustaining your life, which removes the necessity of a full time job.