With the swift downturn of the stock market in early 2022, things changed for near-retirees. They watched as their 401Ks and index funds quickly lost 30-40% of their value.
Index funds track the markets, for good or bad. They typically give some of the best long-term returns outside mega companies like Amazon (AMZN) and Google (GOOG).
The difference between passive index fund investing and income investing. Today, I want to dive into the difference between passive index fund investing and income investing.
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It all comes down to how you generate income from your portfolio. Once you understand how your portfolio will fund your lifestyle, you can better prepare for retirement.
How index funds pay you. When investing in index funds, you want to build a massive net worth based on stocks. Think of this scenario as building a mountain.
Generally, you don’t invest in index funds to live off dividend income. However, if you have invested enough, you may live on the paltry 1.5% yield that my favorite index funds pay.
Commonly, you would sell shares of your index funds to generate income. For example, let’s say you buy one share of the S&P 500 Index Fund (SPY).
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You pay $300 for the share in 2022. When you sell it in 2052, it is worth $1,200. You sell the share and generate $900 in capital gains—paying tax on the profit.
How income investing pays you. When income investing, you receive your cash flow via dividends, and you get them today.
If I invest $300 in the Mortgage REIT AGNC (AGNC) in 2022, I will receive at least $900 in dividends over 30 years. I can reinvest those dividends or use them to pay bills and survive inflation.
When I retire in 2052, I do not have to sell shares. I’ll continue to receive the income from my portfolio indefinitely. I truly don’t need to check the stock market prices very often.
Why don’t most people become income investors? Investing for income seems to be the better deal—why don’t most people do it?
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1) Income investing requires deep knowledge of the markets, commodities, utilities, interest rates, and bond markets.
2) Passive index investing is PASSIVE. It’s tough for most people even to open a brokerage account, let alone pick individual stocks and funds. Passive index investing is alluring and accessible.
3) Many people don’t have time to follow the markets; index investing allows them to dollar-cost average and check the market sporadically.
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4) Index investing gives you a considerable EGO boost because your “mountain” of income will grow into millions of dollars.
5) Index investors see a lot of red in their portfolios because many of their securities are sensitive to interest rates. You have to be emotionally resilient to become an income investor.
Can you do both? Of course, I do all three (adding in Dividend Growth Investing). However, I never plan to sell my index funds.
I plan to let my index funds grow indefinitely and pass them down to my kids and grandkids as part of my estate.
I can teach my kids to leverage these index funds to borrow cash flow against—preventing them from needing to sell shares.
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Income investing is a better planning process. Currently, my wife and I receive $1,000/month in dividends. I am 41 years old, and she is younger than me.
I can plan my income for today, tomorrow, and thirty years from now by income investing. If I don’t need the additional income, I can reinvest it to buy more preferred shares and closed-end funds.
Index fund investing can be deceptive, as near-retirees are finding out now. They may have had $1 million in index funds going into January 2022. By June, they could have been sitting around $700,000.
The problem is they ran their numbers against the $1 million number. Using the old 60/40 rule and 4% withdrawal scenario, $1 million gives them $40,000/year in income.
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The $700,000 number would yield $28,000/year in income. That’s a massive difference if you need this money to survive.
Back to work. If you depend solely on index funds, you may need to return to work until you reach a higher number or markets recover.
Do you want to go back to work in your 60s? I sure as heck don’t want to work anymore. That’s why income investing is essential, even a tiny portion of your portfolio.
Retirement Plus: Use Rents to Supplement Your Income
Mix and match. In the above $1 million example, the couple invests $400,000 in an income portfolio at a 10% yield.
That income allocation pays them $40,000/year. With a market downturn, they may lose some dividend income temporarily. Let’s say it goes down to $35,000.
They still have the $600,000 in index funds to withdraw from for survival. They are sitting in a much better position because they learned the ropes.
I’m living life now. Income investing allows you to see the future NOW. I am living the income life today and enjoying my cash flow during this recession.
I went to Burger King yesterday and bought food for four people—it cost $41. I was shocked, but I pulled out my Dividend Debit Card and paid for it with dividends from Altria (MO) and AGNC.
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As I get paid from my job, I invest in more income stocks. I also buy index funds for long-term appreciation and capital gains. However, my main goal is to purchase income today to spend this cash flow tomorrow.
Conclusion. Yes, there is a massive learning curve for income investing. I have resources to get you started.
I say this all the time—start small. Start with $200 in an income portfolio on M1 Finance. Or go to a full-service brokerage (I use Wells Fargo and Charles Schwab) to buy preferred shares.
The Magic of Cash Flow
Watch your investments pay you for a while. Use this income, even $5, to buy something. Enjoy spending money knowing that next month it will return.
Income investing is akin to having a self-refilling checking account. If you don’t check in a month or two, you’ll have more money than the last time.
Index funds have their place in your portfolio, but don’t fall for the term “passive.” In retirement, selling shares will stress you out, especially during a market downturn.
Income investors will be calm and collected—spending their income the same as they have for the last 30 years. I am a massive fan of income—do you enjoy spending money? Good Luck!
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. All Right Reserved Military Family Investing
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