Many of us tout the benefit of investing for income. It beats the “hope and pray” approach so many people take on as a strategy for investing. Income investing has a slightly different goal than investing for appreciation. It’s to focus on monthly or recurring income. It’s not about whether the price of the asset goes up or down. The ultimate goal is to have your monthly income from your investments exceed your fixed monthly expenses. If you can achieve that, then you’re financially free.
Many investment gurus remark on learning to make direct, active investments into an asset class like real estate, cash flow businesses or oil. I agree to an extent. However, a portion of your assets can go towards true passive income where there is no active management or selection involved. This post is targeted towards that portion of your portfolio.
Public Market ETFs to Consider
I think the asset classes that produces the most income in the public markets are: master limited partnerships (MLPs), real estate investment trusts (REITs), mortgage real estate investment trusts (m-REITs) and business development companies (BDCs). Investing in all four of these investments simultaneously will help provide diversification and reduced portfolio risk.
Use 4 exchange-traded funds (ETFs): AMLP, VNQ, REM, and BIDZ
Master Limited Partnerships (MLPs)
An MLP, is a limited partnership that is traded publicly. This investment vehicle combines the tax benefits of a limited partnership with the liquidity of publicly traded securities. MLPs typically own all the energy infrastructure like gas pipelines, storage containers, refinery services, transportation, and logistics support for energy companies. MLPs are great because they are like the toll-takers on the oil highway. They aren’t as affected by the price of oil as other asset classes within the energy complex like the exploration & production stocks.
One of the easiest ways to invest in this asset class is to simply purchase an index ETF that tracks the MLPs. This index ETF will allow you to invest in roughly 30 different MLPs, so you don’t have any single company risk. Right now, an ETF like $AMLP is producing an annual yield of 10.68%. MLPs price fluctuates so the yield it may be producing at any time may be more or less. There is a chance to generate appreciation or depreciation on the investment if the price rises or lowers and you sell. The strategic goal in an investment like this is to hold forever and generate income.
Real Estate Investment Trusts (REITs)
A REIT, is a company that owns or finances income-producing real estate. REITs provide investors of all types regular income streams, diversification and long-term capital appreciation. The strategic focus of this type of investment is income, but it can also produce capital appreciation. Perhaps more than MLPs. REITs are companies that own the real estate for malls, hospitals, residential and commercial real estate. All of these types of real estate produce income from rents.
One of the easiest ways to invest in this asset class is through an index ETF, like $VNQ. This ETF invests in any REITs in the index. This allows you to avoid any single investment risk and diversify your investment over many REITs. Right now, $VNQ is producing an annual yield of about 4.4%. This may be the lowest income producing asset class of the four, but it has the most potential as well as some capital appreciation, which should be factored into the investment decision.
Mortgage REITs (m-REITs)
Mortgage REITs, or m-REITs, are a slight variation on the real estate investment trust. These companies focus on the property mortgages versus the actual real estate. These are more of a financial instrument, though you are investing in a company. These m-REITs loan money for mortgages. They also purchase mortgages and mortgage-backed securities. They generate income from the interest they earn on mortgage loans. Many m-REITs goose their returns by adding leverage. Since they make their money on the spread between what they borrow at and what they loan at, they can also use leverage to increase return. Leverage is an investment risk, so be sure to factor that into your investment decision.
This asset class can also be invested in through an index ETF. An ETF like $REM invests in many m-REITs, so the investor would not have any single stock risk. Right now $REM produces a yield of 8.7%.
Business Development Companies (BDCs)
A BDC is a company that invests in small and medium-sized companies to help them grow in the early stages. They are similar to closed-end funds and have the liquidity of a public security. BDCs provide mostly debt instruments like short-term loans, bridge financing and secured loans to these companies. BDCs are typically investing in private companies so this gives an investor another layer of diversification by investing in private equity.
There are several ETFs that can help in investing in BDCs. There is a BDC index and the ETF, $BIZD invests in companies in that index. There are several other types of ETFs in this asset class and it’s important to do your research, more than any of the other ETF types. An ETF like $BIZD is producing a yield of 8.02% right now.
Putting It All Together
You can produce 3 times the 10-Yr Treasury yield by using a blend of these types of investments. Currently, the 10-Yr Treasury is yielding 2.3%. Generating an income of 7% or more is possible with a diversified approach using the investments we talk about above. This approach is also diversified in that you’re investing across 3 sectors — real estate, financial instruments (including mortgages/debt/loans) and the energy sector. You’re also investing in different strata of the corporate structure as well as in public and private equity.
It is critical to evaluate the income produced each month, not the price or capital appreciation. This is just one aspect of a good income portfolio. Combining this with an active method of investing can be a great approach to building multiple streams of income. Remember, if you build enough income, you can quit your job and be financially free!
Disclaimer — The above references an opinion and is for information purposes only. It is not intended to be investment advice.