I’ve talked a lot about creating a passive income stream by investing. By this, I mean you can use the income from your investments – i.e. dividends and distributions, and to a lesser extent capital gains. However, I recently had a discussion with an individual about how this can be a difficult source of income to rely on – and he was correct to an extent.
Investment Income You Can Rely On
It is very difficult to maintain investment income you can rely on. As with all investments, there is risk involved, and as a result, the amount of income you receive is not guaranteed. In fact, companies must still have their Board of Directors declare the dividend each time it is issued. For many companies this is routine, but if the company is experiencing financial difficulty, it is not uncommon to suspend a dividend.
So, what types of investment income can you rely on? Well, for starters, you can diversify into a dividend paying fund such as the Dow Dividend Select ETF (DVY). This ETF is composed of the highest dividend paying stocks. If one company were to cancel their dividend, the ETF would just replace it with the next highest paying dividend stock. As a result, the holder of the ETF could still expect a reasonable dividend payment from the ETF each month.
Another type of investment income you can rely on is an annuity. While there are many critics of annuities (including myself to some extent), they are contractual guarantees to provide a certain amount of income each month. Since they are insurance contracts, they usually are also backed by state insurance boards, so the risk of default is very minimal. The difficult part of annuities is the way they are sold – through insurance salesmen who earn outrageous commissions for selling the products. As a result, you MUST do very large amounts of diligence before investing in these products.
Investment Income You CAN’T Rely On
Most investment income can’t be reasonably relied on. First is capital gains. This is income from the sale of an investment for profit. Since you can’t really predict with certainty the amount of you gains and how often they will occur, you can’t rely on this income.
With that, you can’t also rely on mutual fund capital gain distributions either. Each year, most mutual funds pay out the capital gains as distributions at the end of the year. This distribution is based on what the fund manager earned you throughout the year. This is really hit or miss because some years the manager may have done a lot of trades and created a lot of capital gains, and other years this may be minimal. Read the prospectus and do your own technical analysis. In fact, there are low-turnover funds that pride themselves on minimizing capital gain distributions for tax reasons.
Even if you look at my Multiple Income Stream Reports, my investment income varies quite a bit from month to month. On the whole, it does generate a nice amount of income, but it is not reliable from month to month.
Readers, what are your thoughts on investment income? Do you think you could rely on it? What about during retirement?