Income investing is a strategy to create a portfolio filled with securities that provide steady returns through payments. Throughout the equity markets, dividend-paying stocks create a somewhat steady stream of income, although dividends are based on a company's profitability and may be interrupted at any time. In the fixed income markets, bonds provide a steady stream of income in the way of principal and interest payments made by a government or company. Either asset class carries with it an inherent set of risks, although the fixed income market is historically safer and the returns more modest.
Investors perform income investing in the equity markets by hunting the best-of-breed companies in an industry that pay consistent quarterly dividends. Some companies have historically paid dividends for decades, and boast of increasing payouts on a quarterly or yearly basis. Given that some investors rely on dividend income as a sole source of revenue, a solid dividend-paying track record is a positive sign for income investing.
The true value of a stock includes two components: the stock price and the dividend payout. Income investors are searching for a respectable dividend yield, which is calculated by dividing the annual dividend by the stock price. Dividends are taxable as income by most regional and local governments, which influences total returns.
Another feature of income investing in the equity markets is adhering to a buy-and-hold strategy. This is because the purpose behind income investing is to generate long-term growth in a portfolio, and receive steady returns. Consistent earnings growth at a company is vital, because profitability is necessary for dividend payments not only to continue, but to increase.
One way to ensure that dividend payments will continue is to invest as a preferred shareholder. These investors receive a fixed dividend payment quarterly. Although a company's board of directors may still opt to discontinue a preferred dividend, it happens as a last resort and only after a common-stock dividend ceases.
Fixed income is another form of income investing because, as the name suggests, it provides a steady and fixed income to bondholders. The amount of the distribution will vary depending on the value of an initial investment. In the US, certain government bonds pay interest on a loan every six months until the contract maturity date, at which time the face value of the debt instrument is returned to the investor. Corporate bonds tend to carry more risk than government bonds. If a company files bankruptcy or defaults on a loan, bondholders are at risk of not being paid.
