Today, I want to share with you 7 different types of investment income you can earn.
Now, not all the investments you make are going to generate income for you, but your goal should be to fill about 80% of your portfolio with income-producing money machines.
Here Are The 7 Types of Investment Income
Now, there are a lot of different ways to invest, and not all investments produce the same type of income. There are even some investments that produce no income.
As an investor, I'm learning that my focus needs to be heavily weighted toward investments that produce income – right now. I mean, think about it. Why would I want only the potential to make money with my investments?
Wouldn't evident, current profitability be better??
Here's the reasoning: There are some investments that that do not produce income. They only rely on the value of appreciation. In other words, they rely on the underlying company possibly becoming more valuable in time.
On the other hand, investments that produce income income can return all of your original investment funds back to you in the form of earnings. Another way to look at this is as a passive income investment.
The good news is you still own the investment!
Here's a look and a brief description of different types of investment income you may come across as you evaluate investments…
When investing in stock, it is important to make sure the stock regularly pays dividends to its stockholders. A dividend is a payment from the company of whose stock you own. Payments are often quarterly, but they can happen 3 times a year, twice a year, or even annually.
Usually, this dividend payment is a portion of the after-tax profits made by the company; however, it can also represent a payment from reserves or the sale of assets. If so, this will be discussed in the Special Dividends section.
When you evaluate a stock for purchase, it is important to understand where the funds to pay the dividend come from. You want to be a well-informed investor so that you're not just at the mercy of own wishful thinking
You want stocks whose dividends are paid from the profits of the business. Stay away from cash reserves or the special sale of assets. This is because cash reserves and assets can run out. Payments from net earnings continue as long as the company stays profitable.
Dividends are an incredible type of investment income to consider.
As mentioned in the dividends section above, some dividends are not paid from earnings but rather from excess cash balances or when an asset is sold and the funds are not used to purchase new assets or equipment.
These are called Special Dividends because they do not occur regularly, such as quarterly, but are usually one-time events
It is not uncommon for a special dividend to be a higher payment than normal quarterly dividends.
If you are aware of a special dividend distribution likely to come up soon for a stock, it may be a good clue to purchase it now. However, make sure that, on top of special dividends, the stock also makes regular dividend payments from company profits, as I shared above.
Did you know that when money is invested as a type of loan, you can earn interest on those funds? Yeah? Well, neither did I.
This is how savings accounts and certificates of deposits work in banks. However, the interest payments paid by banks are typically the lowest possible interest rate. This is because these funds are considered the safest possible investments, especially with the FDIC guaranteeing of up to $250,000 per depositor and bank.
I'm also learning that you can get better interest rates by buying corporate bonds or baby bonds, instead of stocks. (Baby bonds are our favorite, by the way.) But be careful. Bonds are loans guaranteed by the borrowing company, which are riskier than loans to a government-guaranteed deposit.
Still, bonds are also safer than stocks because if the company was ever liquidated, the bonds must be paid back completely before paying anything back to stockholders. All other debts must be satisfied as well before final proceeds are paid out to stockholders.
The bottom line is you can earn interest (investment income) on certain investments. Choose wisely!
Whenever an investment is sold, any profits on the investment (sales price less the original investment cost) are considered capital gains.
While capital gains are a type of investment income, they rarely occur on a regular basis. In addition, you can't depend on them for reliable payment like dividends and interest.
There are two types of capital gains: short term and long term. A long term capital gain is used for investments older than one year and short term capital gains are applied to investments held for less than a year.
Capital gains are taxable. Long term capital gains are taxed at a lower rate than other income, including interest, dividends, and earned income. Short term capital gains are taxed normally, the same as interest and earned income.
Capital Gain Distributions
Investors of mutual funds (or an exchange-traded fund, aka ETF) may receive capital gains distributions from their investments. Such payments represent proceeds received by the investment fund from selling stocks or other assets.
Sometimes, an investor will declare a capital gains distribution on their taxes even if they didn't receive any cash from the event.
This is obviously a negative return when the investor declares taxes without receiving a cash distribution from that investment, which mean the IRS won't penalize them.
Keep in mind that if the investment is in a mutual fund or stock, a portion can be sold to pay any capital gains distribution tax that results in a reduction in overall value.
You could own an investment that is operated and managed by another company (or individual) who pays you a royalty based upon the income they generate from that asset.
A common example of a royalty payment is when a musician receives a small percentage from each sale of their songs by a music company.
Nowadays, photographers can earn royalties every time one of their pictures is used by another company or website.
Other investments that can make royalty payments include operators of oil, gas, and mineral properties to owners of that land. Being a singer, songwriter, and generally-creative person, this is of great interest to me.
A new and exciting method of sharing profits in an investment is through revenue sharing. Let me show you how it works.
Have you ever heard of Angel investing? Well, angel investing investing involves helping new investors in the early startup phase of business. It's the time when most other investors shy away from investing because new businesses are high-risk.
In return for financing a newcomer, angel investors usually come in as a lender. They often own equity in the company they're investing in, their goal being revenue sharing.
An angel investor wants a percentage of that top-line revenue.
Revenue sharing works a lot like this, and you basically get paid before everyone else! Because of that, I like to call revenue an “income angels.” The yields you can earn are HEAVENLY.
Keep an eye for these opportunities since they can generate a hefty income in a short time.
The Power of Compounding
As you can see from the above examples of the different types of investment income, they are not equal.
At the minimum, you should focus on investments that regularly and reliably make payments from profits. That way, you can reinvest those earnings right back and get compound returns on your investments.
In other words, the income you earn on your investment also starts earning returns.
I like to say, “I like the money that my money makes. But I like the money that my money's money makes even more!”
With the power of compounding, you can see your investment principle rise dramatically over the years, especially when starting young.
The Rule of 72
Now, here's some practice if you want to know how quickly your money can double using compound interest.
It's easy. Apply the rule of 72.
By dividing your annual rate of return by 72, you can see how long it takes to double your money.
For example, if you earn 2% interest on a $100,000 investment and regularly reinvest your earnings, it would grow to $200,000 in 36 years (72 divided by 2 percent).
However, if you got an average annual return of 5% on that same $100,000, you'll reach $200,000 in just 14.4 years!
That is the power of compounding at work and at The Income Investors, we show you how to make the most of this incredible power!
Thanks for reading, and see you in the next article!