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?
This post was written by
Robert is the founder and editor of My Multiple incomes, a personal finance site dedicated to highlighting how anyone can create multiple income streams and diversify their cash flow.
Thanks for sharing. I love learning about investing, as it is one of the areas I need to learn more about. Risk is certainly impossible to avoid, but you gave some great tips to decrease it.
I’m trying to build up my dividend stream. I have a lot of individual stocks that pay dividends, but I should also buy that ETF that you talk about DVY…
Gotta love dividends
Like 20s finances, investing is not my strong suit. Thanks for such a thorough post on how to avoid risk. I really appreciate it.
I would suggest to reinvest all investment income back into the investment if you’re in the accumulation stage of saving/investing. Taking income from investments is most suitable for retirees. Younger people should do everything they can to grow the size of their accounts while they still can.
I have some bonds that generate a little bit of investment income that’s reliable — at least for the term of the bond. I just reinvest all of my dividend income, so haven’t been paying enough attention to that to even have a general idea of how reliable it’s been in the past. I do know retired people who rely on investment income, so I think it’s doable as long as you are diversified enough to minimize the impact of losing income from a particular source.
Annuities you can rely on. There will be no growth in the principal and income is fixed. Good for peace of mind.
Even annuities could be at risk if the issuing company has problems. You can’t really rely on anything whether it be your job or your health or dividends, etc. That is why it is important to keep several irons in the fire.
Yes, if you purchase an annuity, you should look for a top rated company.
Thanka, I will definitely check out the ETF. Sounds interesting.
Over the next 5-6 years, I am shifting more of my investments to dividend funds.
My personal opinion is to guarantee one’s retirement income using as little money as possible. Then use the remaining portfolio to grow untouched. Too many people are looking for the walmart of investments/products. No such investment works and those that appear to- often don’t work because of the sequence of returns and lack of guarantees.
I tried to rely on some investment as my supplemental income, but since it’s so inconsistent, it’s hard to budget for it accordingly. so i just don’t even consider it anymore.
Believe it or not, I currently do not have investment income that I rely on. It is just too unpredictable to be considered a steady source of income. I do think it is wise to find ways to increase your primary income stream, ie. your job salary. Work hard and keep up your resume updated.
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Love the dividend ETF suggestion, no headache following companies. Just set on auto pilot and reap a monthly payout.
I reinvest dividends and cap gains in order to compound our wealth. Over time, it really adds up.