The Advantages & Disadvantages of Passive Income Investing
Today I want to explore the pros and cons of income investing.
Even though, I’m an income investor at heart. And I’m all for putting in place an income investing strategy.
I always believe there is value to assessing the opposing point of view.
So, let’s not delay. And dive into today’s topic: investing for income pros and cons.
Disclosure: At no cost to you, I may get commissions for purchases made through links in this post.
10 Pros And Cons Of Income Investing
Allow me to start with a summary list of the advantages and disadvantages we income investors face. It will serve as our guide for the rest of the article.
5 Advantages Of Income Investing
- Multiple passive income streams
- Investment income in bear markets
- Lower risk investment options
- Reduced investment portfolio volatility
- Preferential tax treatment versus earned income
5 Disadvantages Of Income Investing
- Tax inefficiency versus other investments
- Lower potential total returns
- Increased interest rate sensitivity
- Lost purchasing power from inflation
- Low-interest rates and yields
So, that’s my quick list of pros and cons of income investing.
Next, I want to describe an income investing strategy. And, discuss investment income portfolios.
To make sure we have a solid foundation in place. For discussing the benefits of income investing. Also, reasons why this approach to wealth management may not be the best for you.
What Is An Income Investing Strategy?
An income investing strategy involves buying income-producing assets. And accumulating them in an income investing portfolio.
The goal is to generate the highest possible cash flow. That is consistent with an income investor’s risk tolerance.
Furthermore, fixed income investing is a subset of this approach. Where investor income is produced from bonds and certificates of deposit (CDs).
But today, we are talking about a more inclusive approach. Where an income investor’s portfolio also has high-quality dividend-paying stocks and real estate.
Pros And Cons Of Income Investing: Save Time
Regardless of the way you go about investing. Be sure to save time managing your finances.
We consolidate all of our investment accounts. And spending in one place online. And that place is Personal Capital.
It’s a great tool for managing all of your spending and investments. With only one set of login credentials to remember.
Best of all, Personal Capital is free to sign up and use. You can learn more about Personal Capital here.
But back to today’s topic. Because this discussion about investor income strategy leads me to another point. Specifically, what a typical income investor’s portfolio might look like…
Model Portfolio For Income
Income portfolios are constructed from a variety of assets. And have different allocations to those assets.
Thus, every income investor’s portfolio will be different. Here’s a simple model portfolio for income. To illustrate my point.
| Income Asset | Asset Allocation |
| CDs | 5% |
| Bonds | 40% |
| Dividend stocks | 40% |
| Real estate | 15% |
| Total | 100% |
If I chose to break the income portfolio down further. You would see different types of income investments.
First of all different types of bonds. For example, treasury bonds, corporate bonds, municipal bonds, and high-yield bonds. Sometimes high-yield bonds are referred to as junk bonds.
Furthermore, dividend stocks from a variety of sectors. Such as utility stocks, consumer goods stocks, and financial services stocks.
And, real estate holdings in different forms. Where rental properties and real estate investment trusts (REITs) are some of the most popular types of income assets.
Finally, an income investor’s portfolio may hold a combination of investment vehicles.
Specifically, individual stocks or bonds. Mutual funds, and exchange-traded funds. And real estate.
Thus, investing in income funds, stocks, and bonds. Also physical assets for diversification that they they provide in the from of real property.
By definition, fund portfolios are just a collection of individual securities. Put together and sold by an investment firm.
Pros And Cons Of Income Investing: Keep Costs Low
Whatever investment approach you choose. Be sure to keep your investment costs low.
Specifically, choose low-cost index funds. And buy and sell stocks, bonds, and funds for free. I use the Webull app to do so.
Webull is fast and easy to use. Also, it has some excellent research capabilities.
You can learn more about Webull here.
Okay. So, we know the type of investor income strategy we are discussing. And what types of assets an investing income portfolio holds.
Now we can dig in. And discuss the pros and cons of income investing.
Starting with the 5 advantages of investing for monthly income…
1. Multiple Passive Income Investing Streams
It’s always a good idea to diversify your income streams. Furthermore, investor income fulfills this need.
Since the income investor’s goal is to generate the highest possible cash flow. That is consistent with their risk tolerance.
By reducing investment risk through income asset diversification. Multiple streams of a passive investment income are created.
Here are the steps. First, decide on asset allocation. Secondly, purchase investments.
And after that, investing for monthly income requires very little effort. Thus, it is passive income. Sometimes referred to as portfolio income.
2. Investment Income in Bear Markets
It’s been quite a few years since we had an extended bear market in stocks. A bear market is defined as at least a 20% decline. In one or more of the major stock market indexes.
We will have another bear market for sure. I just don’t know when. Or, how long it will last.
Regardless, most if not all, of the investor’s income will be paid during a bear market. Even though the overall value of an income portfolio may temporarily decline.
Furthermore, the income reduces the need to draw down assets. At low prices during a bear market. Because the income is there to meet the investor’s financial needs.
Finally, there are multiple ways to increase portfolio income. No matter the conditions in the stock market.
3. Lower Risk Investment Options
Some investors have a very low-risk tolerance for investment losses. Yet desire a return on their money.
And income investors can choose investments that are guaranteed. Or, investments that have a small potential for loss.
For example, certificates of deposit are insured by the FDIC. That stands for the Federal Deposit Insurance Corporation.
Furthermore, treasury bonds are secured by the full faith and credit of the U.S. government.
Finally, it is unlikely investors will incur losses on the highest quality bonds that are rated investment-grade.
Be sure to get good rates for your savings. And certificates of deposit.
CIT Bank has some excellent options. Since there is no need to settle for the low rates your local bank offers.
Here, you can learn more about CIT Bank fixed income investments.
4. Reduced Investment Portfolio Volatility
Those same investments I just mentioned also have very low volatility. Meaning their asset prices do not move by large amounts. If, they move at all. In the case of certificates of deposit.
So, for those who cannot stomach the sometimes gut-wrenching moves in the stock market. Then income investments offer a viable alternative.
5. Preferential Tax Treatment Versus Earned Income
Investing income is more tax efficient. When compared to earned income.
This is a big advantage of income produced by a portfolio.
First of all, dividends have historically received favorable tax treatment. As compared to the tax rates on ordinary income. Since qualified dividends are taxed at a much lower rate.
Furthermore, neither interest income from CDs and bonds nor dividend income is subject to employment taxes. Specifically, social security tax.
So, if you are investing for retirement income. It will be taxed at a lesser rate than the earnings made from your job. This makes your investment income go farther in retirement.
Nevertheless, taxes do apply. So don’t forget about them. When calculating the amount of investment income you expect to receive.
Okay. That concludes the 5 pros of income investments. So, one-half of our discussion about the pros and cons of income investing is complete.
Now we can handle the 5 disadvantages of income investing…
1. Tax Inefficiency Versus Other Investments
Other investment strategies focus on growth investments. Specifically, appreciating assets that increase in value.
By investing to achieve capital gains from these asset types, an investor can defer taxes. And pay them only when an investment is sold.
On the other hand, interest and dividends are taxed when received. Leaving the income investor with an immediate tax bill.
That pulls dollars out of an income portfolio. And sends those dollars to the government. Leaving less money in the portfolio to earn income.
Pros And Cons Of Income Investing: Open An IRA
On the other hand, there is a good way to get around tax inefficiency. That this investment approach presents. To do so, save on taxes and hold income investments in an IRA.
Either a traditional IRA or Roth IRA does the job. For the different types of tax advantages, they offer.
Have you been meaning to open an IRA? And start investing for a secure retirement?
If yes, M1 Finance is an excellent choice for your IRA account.
Opening and funding an account with M1 is easy. And it’s free to do so.
You can learn more about M1 Finance here.
But now, back to our list of investing income cons…
2. Lower Potential Total Returns
The lower risk and reduced volatility that many income investments offer has another downside. Specifically, lower investment returns. When compared to a growth investing strategy.
It is the classic risk versus reward trade-off that all investors face. Less risk usually means lower total investment returns.
Regardless of the amount of investment income received. Because being an income investor means passing on some very good investment opportunities.
Specifically, investments in growth companies. Where management chooses not to pay dividends.
For example, stocks like Amazon, Tesla, and Facebook. The stocks of these companies have done very well for their investors.
But since they do not pay dividends. Or, an income of any kind. You won’t find these 3 stocks in an income portfolio. Nor, others like them.
3. Increased Interest Rate Sensitivity
The prices of income investments are sensitive to interest rates. Specifically, most income asset prices are inversely related to the level of interest rates.
With interest rates at all-time lows (more on that a little later), they have only one direction to go. That direction is up.
What does this mean? When interest rates go up, they bring the overall price levels of income assets down.
4. Lost Purchasing Power From Inflation
Inflation is said to be an income investor’s worst enemy.
Because inflation is the steady increase in prices for goods and services. Those goods and services that we consume daily.
So, inflation decreases the purchasing power of fixed income investing. For example, CDs and bond investments.
We haven’t had high inflation over the past 15+ years. But there is concern it will return because of massive government spending.
On the other hand, dividend stocks hedge or offset inflation. Because of dividend increases. Since it is normal for companies to increase their dividends regularly.
Pros And Cons Of Income Investing: Dividend Stocks
I have mentioned dividend stocks several times throughout the article. Since I am a big fan of dividend investing.
And dividend stocks are my favorite form of passive income investing. They make up a large portion of my income investments.
To find good dividend stocks. I use the Simply Investing report.
Simply Investing delivers high-quality dividend stock recommendations to my inbox every month. Based on the latest stock market trends and data.
Looking for a few good dividend stocks? To add to your investing income?
Then you can learn more about Simply Investing here.
Next, onto our last disadvantage that income investors face. Then, I will wrap up.
5. Low-Interest Rates And Yields
We have been in a low-interest-rate environment for many years. Driven by the Federal Reserve propping up the economy with easy money.
Also, the stock market is at a high level. Thus, reducing dividend yields. Since dividend yields are inversely related to stock prices.
So, years ago, a low-risk income portfolio yielding 5-6%. Was pretty easy to put together.
But now, because of historically low interest rates and yields. You have to work hard to construct an income portfolio delivering 4%.
Without taking on too much risk. Because finding higher interest rates and yields today. Mean a greater chance for investment losses.
Okay. Allow me to offer a few closing thoughts…
Pros And Cons Of Income Investing: Wrap Up
To wrap up the pros and cons of income investing. Let me summarize what we have discussed.
Use these 10 pros and cons as your complete guide to income investing. To determine if this investment strategy is right for you.
5 Advantages Of Investing For Monthly Income
- Multiple passive income investing streams
- Investment income in bear markets
- Lower risk investment options
- Reduced investment portfolio volatility
- Preferential tax treatment versus earned income
5 Disadvantages Of Investing For Monthly Income
- Tax inefficiency versus other investments
- Lower potential total returns
- Increased interest rate sensitivity
- Lost purchasing power from inflation
- Low-interest rates and yields
That’s it for today. Good luck with your investments. No matter the strategy you choose.
Pros And Cons Of Income Investing: More Reading
- All the best investing articles from Dividends Diversify
- Quality stocks for an income portfolio
- A favorite ETF for income and growth
Best Income Investing & Finance Resources
First of all, I mentioned several tools and apps I use to make the most of our income investments.
Furthermore, I have summarized them here for your convenience.
Finally, most are free to sign up and use. Or, offered at a very affordable price. So, you can make the most of the income from your investments!
- Trade stocks for free with the Webull app
- Get dividend stock recommendations from Simply Investing
- Get top stock picks from Motley Fool
- Open an IRA at M1 Finance
- Manage all of your finances with Personal Capital
- Make interest income on your savings from CIT Bank
Author Bio, Disclosure, & Disclaimer: Please join me (Tom) as I try to achieve my goals, find my next place to live, and make the most of my money. However, I am not a licensed investment adviser, financial counselor, real estate agent, or tax professional. Instead, I’m a 50-something-year-old, early retired CPA, finance professional, and business school teacher with 40+ years of DIY dividend investing experience. I’m here only to share my thoughts about essential topics for success. As a result, nothing published on this site should be considered individual investment, financial, tax, or real estate advice. This site’s only purpose is general information & entertainment. Thus, neither I nor Dividends Diversify can be held liable for losses suffered by any party because of the information published on this website. Finally, all written content is the property of Dividends Diversify LLC. Unauthorized publication elsewhere is strictly prohibited.