Income Investing: Past, Present & Future
Generally, when people mention ‘investing’, many imagine rich investors in suits investing their funds in order to create profit. Also, many consider ‘good investing’ to be only buying stocks that have high potential to be sold at a high price in the future and selling them at a higher value, generating higher profits. However, not every investor’s primary purpose of investing is to grow richer. Some investors are more concerned with generating a regular income or cash that they can use for everyday life. This type of investing is called ‘income investing’. The primary purpose of income investing is, most of the time, to generate as much income as possible while reducing risk.
Income investing started in the nineteenth and twentieth centuries, mostly in western society. In the 19th and 20th centuries, western society was navigated easiest by educated white males with college degrees. Society was very prejudiced against many minority groups. These minority groups included Jews, women, blacks, and homosexuals. The jobs that these people were able to pursue were very limited, and usually included very simple and repetitive work in factory with low payment. This situation gave birth to income investing. An early form of income investing was the “widow’s portfolio”, which meant an investment portfolio created for widows who inherited their husband’s money and properties. Because widows were not able to find jobs that could pay enough income for them to live comfortably, investing in stocks, bonds and assets were the only method that they could use in order to generate cash. Since the primary purpose for widows was not to become rich, but to generate cash needed for everyday life, such as paying bills, purchasing groceries, clothes and many other appliances, their investment vehicle served a novel purpose.
Income investing has evolved as an investment vehicle. Nowadays, income investing is not only done by social minorities who are unable to find jobs, but also by many professional investors. What are some types of assets that are used as income investments nowadays? Fixed income securities such as money market securities are a conventional method of income investing. Other than this, the most common fixed market securities that are used for income investing are bonds, real estate, and stocks that consistently pay out dividends.
Under the category of bonds, there are many choices that an investor can make, income from bonds comes from the interest paid to the investor on a regular basis. Also, the investor receives his principal back when the term of the bond expires. The most common types of bonds used for income investing are corporate bonds, municipal bonds, and government bonds. One of the most significant aspect to consider when performing income investment is the balance between the amount of annual income that can be generated, and risks that follow. One should choose whether to invest in more risky bonds, expecting more annual income, or to invest in less risky bonds, expecting less but stable annual income.
One of the most risky bonds that can generate more annual income is corporate bonds. Corporate bonds, as its name suggests, are bonds that are issued by corporations in order to raise money for their businesses. Just like the other types of bonds, the corporate bonds also pay the interest that is called coupon every year, giving back the principal to the investor when the bond is matured. Usually, many of the corporate bonds have higher rate of coupon than other types of bonds. Another merit of investing in corporate bonds is that, unlike other types of bonds, corporate bonds can be traded freely in a market, and their price is flexible according to the market. This means that the investor can be free from keeping the bond to the maturity in order to get the principal back because they can sell it anytime. It should be noted that there are also problems with corporate bonds, as it involves the most risk at the same time because the companies can default and leave the investor with nothing. For instance, some major companies in many industries had experienced huge downgrades such as General Motors and Fords, or even ended up in default (Delta and Enron). Furthermore, many healthy structured corporations such as Kodak collapsed rapidly, resulting in monumental losses for investors.
Due to the high risk of corporate bonds, there are many investors who choose to invest in other types of bonds. One of those bonds are Municipal bonds. Municipal bonds, as the name suggests, are bonds issued by states, cities, and counties. It works the same as the corporate bonds, the only difference being ,the issuer is the state. States, cities, and counties issue bonds in order to do their public businesses such as building educational institutes, infrastructure such as highways and sewer system, and public buildings such as hospitals. The issuer of the municipal bonds usually pays the investor certain amount of interest at the end of every six month period and also gives back the capital invested at the maturity date. Unlike corporate bonds, the buying and selling of municipal bonds is not free. One of the merits involved in investing in municipal bonds is that many of the municipal bonds are tax-exempt. The interest income that an investor receives from municipal bonds is free from federal income taxes. Furthermore, interest income received from securities which are issued by state government is exempt from both state and local taxes, in many states. However, although the municipal bonds are much less risky than corporate bonds, it does not mean that they are free from risk. The municipal bonds of nowadays still have the risk to be bankrupted, as was demonstrated in Jefferson County, Alabama in 2011. Bondholders of the Jefferson County not only failed to receive interest, but also failed to receive the principal itself due to the bankruptcy in 2011. Other than this incident, overall ten municipalities were bankrupted in 2011 in United States.
Sovereign Bonds are another type of bond that involves less risk than corporate bonds. It is different from a municipal bond because the sovereign bonds usually consist of a government bond. Some major aspects to consider when purchasing government bonds are creditworthiness and sovereign risk. Creditworthiness means the ability of the government to pay back its debts. Unless the government bonds are issued by countries with extremely unstable economies, most of the time government bonds have less risk than many corporate bonds. Sovereign risk or country risk represents possible external situations that might affect the government’s ability to pay back their debts. In recent days, there has been an increasing demand for international government bonds issued by nations with emerging markets, such as: Mexico, Argentina, and Russia. These types of government bonds became famous because they could generate higher yields as the bonds were from markets that were growing rapidly. However, there are also many risks. These bonds are quite volatile. The volatility of bonds are determined by political situations which may negatively affect the ability of such governments to pay back their debts to the investors. Hence many experts suggest that it is significant to notice that the nations with emerging markets nowadays might have severe debt issues and may default.
Other than bonds, there are many other financial instruments that can be used for income investing. One of the most popular methods involves investing in real estate. The merit of investing in real estate as a method of income investing is its natural protection against high inflation. For example, real estate could be a great fortress and buffer for financial planning when one experiences turbulence in other markets. This is the main reason that many income investors put real estate in their portfolio.
Most people think of bonds and real estate when they hear about the income investing. However, it is possible to generate regular income by investing in stocks. The key concept of income investing in stocks is the dividend paid to the stockholders. The income investors usually invest in blue chip corporations. Many blue chip companies have low growth rates because they are already a ‘grown’ firm, however, their merit is that their rate of growth is regular and stable. Hence, instead of reinvesting reserved profits, they pay dividends to their stockholders. One of the significant aspects to focus on while investing in stocks that pay dividend, is safe dividend payout ratios. If the primary purpose of the income investor is to generate consistent amount of income every few months, whether or not the company of an investor’s choice can pay dividend safely is more important than whether the company is able to provide a high dividend yield.
The number of people interested in income investing seems likely to increase in the future due to the retirement of ‘baby boomers’, who were born between 1946 and 1964. Many retired workers who want to keep generating income after their retirement for their financial safety will inevitably look towards income investing. The primary drive of these retired workers would be not to run out of the funds that they have at the time of their retirement and to generate regular income, the percentage of the investor’s account balance each year will be the first thing to consider. It is universally accepted that the ideal percentage that one should take out each year is 4 percent. Any higher percentage would mean higher risk of running out of funds and ending up with significant loss when the market collapses.
Thus, the income investing that started out as an indispensable method for social minorities to generate income for everyday live, evolved and became a popular type of investment method that is done by most of the social groups across income levels. The future prospects of income investing is also positive because many retired workers are looking for opportunities to keep their financial situation safe.
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