The media’s depiction of the stock market often is simplistic and narrow. It comes off like a casino, a place where you put your money down and hope the ball lands on black.
Real investing is far different. It’s ownership of a company, literally, and the benefits of that ownership accrue to you just the same as it does to the major investors who call the shots.
The reason we confuse investing with gambling is that we tend of think of the exit first. Once the stock has appreciated, how much can I get for selling it?
That’s a short-sighted view of the markets, one that leaves aside the tremendous advantage of income from investing. Investment income takes three fundamental forms: dividends, interest payments and distributions.
1. Dividend-paying stocks
As an owner, you are entitled to a portion of the company’s earnings, known as a dividend payment. The board might choose to issue no dividend, and that’s okay if you believe that management is using the cash to increase earnings down the road by reinvesting in the company or through acquisitions.
But most companies, particularly once they get large, do begin to issue a steady dividend. Right now, the combined dividend of the S&P 500 pays 2.17%. If the S&P 500 itself ends the year at exactly the same price level, you nevertheless would earn that dividend income for the year.
2. Bonds and bond funds
Second is interest payments. Most portfolios includes some portion of bonds, and bonds pay interest. Since they are loans, usually to a government or a company, you know in advance how much income to expect. They can also gain or lose value, but if you just hold them the income is predictable.
A 10-year Treasury note right now pays 2.55%, for instance. Part of the reason that bank account savings and checking accounts pay so little interest is because the so-called “risk-free rate” paid by Treasuries is so low.
Same with money market funds and certificates of deposit. As interest rates rise in the future, they too will pay higher rates for income seekers.
3. Other income generators
Finally, you can earn income from investments that offer distributions. Some investment vehicles, such as real estate investment trusts (REITs) and master limited partnerships (MLPs), are set up specifically to generate income at a steady level.
That’s not to say they are risk free, but that the income they produce through rents and toll charges are passed through to the investor. Owned individually, there can be tax implications with REITs and MLPs, so proceed carefully.
These are just three common income generators in the investment markets. There are more exotic funds out there, as well as private equity and options trading. However, even a plain-vanilla retirement portfolio grows as much from income as appreciation, especially as income is reinvested over time.