What is portfolio income?

Authors: Marcia Wendorf

Source: Forbes

What Is portfolio income?

Income can be basically broken down into three types: 

• Earned income is money you receive from work and includes salaries, wages, commissions, bonuses and tips.
• Passive income: Think “unearned” income that can come from a variety of sources, including royalties from creative works, property rent payments, affiliate marketing and income from a limited partnership in which the investor owns a share of a business but does not participate in its operation.
• Portfolio income is income generated from investments such as stocks, bonds, mutual funds, exchange-traded funds (ETFs) or real estate. It consists of capital gains, dividends and interest from a traditional savings account, a money market account, a certificate of deposit (CD) or a bond. 

Portfolio income vs. passive income

Passive income is money received regularly without having to perform active work. Sources can include royalties, a pension, rental income or a business venture in which the investor is not actively involved.

Portfolio income comes in the form of dividends from stocks, mutual funds, exchange-traded funds or real estate investment trusts (REITs). It also comes from interest such as that paid by bonds or in the form of capital gains.

How is portfolio income created?

1. You can start creating portfolio income by buying a dividend-paying stock, most of which pay dividends quarterly. If you don't need the dividend income for everyday expenses, and if the company allows it, consider putting the dividends back into the company to get more shares. This is called a dividend reinvestment, or DRIP, plan. Like all stocks, there is risk with dividend-paying stocks that their share price can go down or that the company can decrease the dividend amount.
   
   Besides looking at the dividend amount per share, also look at the dividend yield. This is the current annual dividend per share divided by the current share price.


2. Buy shares of a dividend exchange-traded fund or a dividend mutual fund. They are both pooled investments that hold securities such as stocks, bonds, REITs and alternative investments. Some ETFs and mutual funds are actively managed while others track an index such as the S&P 500 index.
   
   Money market mutual funds hold short-term Treasurys, such as certificates of deposit (CDs) and repurchase agreements (repos). The yields on money market mutual funds rise and fall along with interest rates. You can buy or sell shares in mutual funds, which are known as NAVs (net asset values), once a day at the close of the market. Shares of ETFs can be bought or sold throughout the trading day.
   
   Bond funds focus on specific types of bonds or on bond indexes. Bond funds are susceptible to rising interest rates. When interest rates rise, the value of shares in a bond fund fall, and when interest rates fall, the value of shares in a bond fund rise. Companies, governments and agencies issue bonds to raise money. A bond has a face or par value, an interest rate and a maturity date. The interest rate reflects the level of risk, and most bond interest is paid semi-annually.
   
   Treasurys, which are issued by the U.S. Treasury, have virtually no risk, while the risk level of corporate bonds is rated by bond rating agencies such as Moody’s, Standard & Poor’s and Fitch, and is based on the bond issuer’s ability to make the interest payments and to repay the principal. Once issued, bonds can be bought and sold on the secondary market, with the price of a bond rising if interest rates go down, and falling if interest rates go up.


3. Capital gains are another way to create income from an investment portfolio. Capital gains derive from the sale of an investment at a profit; for example, if you bought 100 shares of a stock at $30 a share and a year later you sold those shares for $50 a share, your capital gains would be $2,000.


4. Residential or commercial real estate held in an investment portfolio can provide rental income, however, an investor must consider the cost of maintenance as well as property taxes. Real estate is not very liquid since it cannot be sold quickly. A way to avoid these pitfalls is to invest in a real estate investment trust (REIT). A REIT holds a number of properties that have similar characteristics or it can hold mortgages. REITs are traded just like stocks and must pay out 90% of their taxable income to unitholders in the form of dividends. REITs are a good way to diversify an income portfolio since they aren't strongly correlated with stocks.

Portfolio income example

Let's create a fictional investor named Joe. He's male, 45-years-old, married with two kids who are nearing college age. Joe has $50,000 to invest and several investment goals: 

1. In the short run, he'd like his portfolio to provide enough income to help offset the cost of college tuition for his two children
   


2. Joe and his wife would like to start a home improvement project, and any portfolio income could be put towards that.


3. In the long run, Joe would like to see how much income the portfolio could generate as he starts planning for his retirement. 

    

This article was written by Marcia Wendorf from Forbes and was legally licensed through the DiveMarketplace by Industry Dive. Please direct all licensing questions to legal@industrydive.com.