How to Feel Secure in Income Investing
Income investing encourages you to buy investments, such as stocks or bonds, that promise a steady stream of income; among stock investors, income and dividend investing are one and the same. For most of history, investing was income investing. Whether investing in stocks or bonds, in small or large businesses, investors needed income from their investments to cover their daily expenses. They simply didn’t have the surplus cash on hand to let it sit in the market for several years until they could sell and reap their profit.
When you’re investing for income and looking for a relatively safe and steady cash flow, you have several options, ranging from socking away your money in a savings account to investing in dividend stocks.
Savings account: Sticking money in a savings account is one step up from stuffing it in a mattress, in terms of liquidity, security, and potential return on your investment. You can withdraw your money at any time without penalty, and your savings are guaranteed by the Federal Deposit Insurance Corporation (FDIC) up to a certain amount. However, the rate of return is the least of any investment alternative.
Money market accounts: Money market accounts have many of the advantages of savings accounts but not to the same degree. Liquidity is about the same, because you can withdraw money at any time, typically by writing a check. Your money is slightly less secure because it’s not federally insured, but you can expect a slightly higher return on your money. Interest rates pretty much stay in line with the Federal Reserve Bank’s discount rate, which is the minimum commercial interest payment around.
Certificates of deposit (CDs): Less risky and less liquid than money market accounts and more profitable than savings accounts, CDs give you a way to stash your money in the bank and earn a slightly higher interest rate in exchange for your promise not to touch the money for a specific period of time — 30 days to five years. Sell before the agreed-upon time limit expires, and the bank slaps you with a penalty.
Bonds: These fixed-income IOUs provide a fairly secure income stream and generally pay higher interest than you can expect from a savings account or CD. They do have some drawbacks, however. Bond prices can fall, typically when interest rates rise, while the interest rate you receive remains constant.
Dividend stocks: The riskiest of the commonly used income-investing options, dividend stocks also feature plenty of potential benefits. Investors can see returns rise both in terms of share price appreciation and dividend increases. On top of that, dividends are taxed at the low rate of 15 percent regardless of income tax bracket.
The main attraction of most conservative, income-investing options is that they help protect your principal — when the game is over, you can expect to walk away with at least as much money as you started. However, principal protection and risk management come at a price:
A low yield can prevent the investment from keeping pace with inflation, which means you may walk away with the same amount of money but less purchase power because that money is now worth less.
Taxes can chip away at any gains. Don’t forget that anything not in a tax-deferred account is subject to tax. Interest from savings accounts, CDs, bonds, and money market accounts is usually treated as standard income and taxed accordingly.