What Is Income Investing? A Beginner's Guide

At a glance:

• Income investing prioritises the generation of returns from income – cash flows from assets held – over capital growth.
• Income is typically generated from dividends (on shares), coupons (on bonds) and fund distributions, but it isn't guaranteed.
• Portfolio construction – considering asset mix and diversification – is vital to building a stable income stream.
• Structuring your investments to prioritise income can change your portfolio’s risk profile and, in some cases, increase certain risks. Here we outline some key risks of income investing and practical ways you can manage them.

What is income investing? 

Income investing is the process of investing with a simple goal: to receive money periodically from a portfolio by buying assets that distribute cash regularly (rather than needing to sell assets for cash).

Income investors tend to prioritise building a stable income stream over long-term capital growth. Income investors may use assets such as dividend-paying shares (also known as income shares), interest-paying bonds or income-distributing funds. Income investors may have different financial goals in mind when investing, such as planning to supplement their salary or receiving an income in retirement.

Note: This guide is intended to be educational. Some of the products or strategies explained may not apply to products or services offered by J.P. Morgan Personal Investing. If you are unsure, you can call our experts.

How does income investing differ from growth investing?

While growth investing focuses on asset price appreciation over time (capital growth), income investing focuses on generating a regular stream of cash payments (such as dividends or bond interest).

In practice, many “income” investments can still grow in value, and many “growth” investments can still pay some income. That said, investors should be aware that prioritising income can come at the cost of some performance, according to Paul Hillis, Wealth Practice Manager, so needs to fit your requirements.

“One thing we often discuss with clients is whether they need income or not, and the trade offs. In general, capital growth focused portfolios can outperform on a total return basis over the longer term, so if a client doesn’t actively need an income stream, it may not be right.”

Total return is the overall gain or loss on your investment(s) over a given period, and combines both the change in its value (any growth) plus any income received.

Many investors use a blend of both strategies, and this balance may change over time with changing priorities and risk tolerance.

For a more detailed explanation, see our income vs growth article.

Who might consider investing for income?

“Priorities may evolve as circumstances change. In the early years, an investor may have a longer time horizon. Focusing on capital growth might be more suitable when a client is better placed to tolerate short-term fluctuations in capital value, with the aim of building wealth over time.”

Charlotte Wheeler, Senior Wealth Manager

She adds that, “closer to retirement, when an investor may be thinking about drawing on their investments, emphasis may shift towards income generation. We can help clients build more predictable distributions, while still managing inflation and market risk.

However, there isn’t one ‘right’ pathway. The approach that fits best will depend on the investor’s goals, expected spending needs, other sources of income, and their ability and willingness to take risk.”

You might consider investing for income if you:

• have received a lump sum through inheritance, via the sale of a business, or from a property sale, and want to use it to generate a supplementary cash flow,
• are already retired or are nearing retirement and are looking to have some of your investments focused on long-term growth and others providing an income to cover some of your living expenses.
• have a variable monthly income (for example, if you’re self‑employed or freelancing) and would like to supplement this using your investments,
• or want to reduce your working hours, and feel a secondary source of income may minimise any resultant salary gap.

You could consider having some of your portfolio focused on income investments, and some still focused on long-term growth to target other financial goals further down the line, such as putting your children through university.

How can you use income investing to unlock flexibility?

Generating a regular cash flow

Income-based investments may provide periodic payments (such as dividends or bond interest). Over time, this can be structured to build a steady stream of cash flow that can fund living expenses, be reinvested to grow your portfolio, or help you stay invested through volatile markets by reducing the pressure to sell at the wrong time.

Potentially reduce the need to sell investments to fund spending needs

With income investing, you can generate cash flow while continuing to hold your underlying assets. This can be a more practical way to cover outgoings – particularly known/expected outgoings – than selling investments. While not guaranteed, income investors can build stable cash flow streams to cover planned expenses, which can reduce the risk of being forced to make a sale at unfavourable times.

Diversification

Adding an income stream – from sources such as dividends, bond interest, or rent – means some of your return comes as regular cash payments, so your portfolio return is less dependent on prices rising to make money. Bear in mind, you don’t have to take the income out. If you reinvest the income you receive, you can buy additional investments that may generate their own future income, allowing you to tap into the potential of compounding. Over time, this can help increase the value of your portfolio and its income-generating capacity.

How do investment portfolios generate income?

Investors can receive income from their portfolio in different ways. The primary methods used by income investors are:

• By investing in the equity of companies that pay dividends.
• By buying bonds, which pay regular coupon/interest payments.
• By holding collective investments – like ETFs or investment trusts – that generate income from one or a combination of the above.

Income from equities: dividends

What are dividends and how are they paid?

Equity income is usually in the form of dividends, which are payments made to shareholders (investors) of a company. Not all companies pay dividends and it is important to remember that equity dividends are usually discretionary. A company's board of directors may decide that it is in the best interests of the company and its shareholders to pause, lower or stop paying dividends to its investors. 

Why some companies pay dividends (and others don’t)

There are several reasons why some companies may pay dividends:

• Attract and keep investors: companies may decide to distribute a portion of their profits (also known as earnings) to their shareholders to encourage investment in the company. Some investors, particularly those focused on earning income through their investments, favour companies that pay attractive dividends.
• Indicate financial health: a company’s ability to distribute healthy dividends is seen as a positive financial metric, especially if the dividends regularly increase and are well covered by earnings.
• Return profits to investors: Some companies pay dividends because they have reached a scale that makes further growth challenging, and at this point may start to pay investors a dividend.

While it is common practice, especially for mature companies with stable revenues and earnings, there are a variety of reasons why a listed company may choose not to, including:

• Focus on growth: Companies in earlier stages of development may choose to reinvest available cash in pursuit of this higher growth, aiming to create a more profitable company in the future.
• Financial caution: A company may prefer to retain its cash for self-preservation if experiencing cash flow issues or weaker earnings. Investors may, however, react badly if a company that typically pays a dividend decides not to.

What is dividend yield?

The dividend yield is the annual dividend paid per share, divided by the current share price, expressed as a percentage. It shows how much the company pays in dividends each year, relative to the share price.

Dividends are declared at the company’s discretion and aren’t always guaranteed.

Dividend yield = annual dividend per share / share price

Is a high-dividend company regarded as a better investment?

Dividend-paying equities are not inherently 'better' than companies that don't pay a dividend. A company's strategy and priorities will dictate how it uses capital, and paying dividends is just one approach. Investors seeking income from their investments might look for companies with a higher dividend yield, but it's important to know that dividend yield doesn't indicate how risky an investment is.

For instance, a company may choose to reinvest its cash into growth, repaying debt, buying back shares, or simply hold cash for flexibility. In this instance, these companies do not pay dividends to investors, however, this doesn’t necessarily mean that dividend-paying companies are ‘better’.

Wealth Practice Manager Paul Hillis explains that it is important to not equate a high dividend yield with a safer or a higher-quality investment.

Dividend yield is just the dividend / share price, so it may look high simply because the dividend is generous or because the share price has fallen. In some cases, an unusually high yield reflects market concerns about the business, and the dividend may later be reduced (sometimes called a ‘dividend trap’). For that reason, high-dividend stocks can sometimes underperform or carry higher risk than their yield suggests, and yield alone isn’t a reliable measure of either risk or expected return.

Finally, dividend-paying companies are not evenly distributed across markets. Some sectors and regions have a much higher concentration of dividend payers than others. If an investor targets only higher-yield equities, they may become overexposed to certain industries (such as utilities, telecoms, consumer staples, financials) or geographies, therefore reducing diversification.

Our guide to equities explains what a dividend yield is and also the role that equities play in a portfolio.

Income from bonds: coupons

Bonds often fall into a category of investments known as ‘fixed income', and sometimes people use the terms interchangeably. 

The term 'fixed income’ reflects the fact that many bonds typically pay regular, set amounts (the income from the bond, sometimes called the 'cash flow') to the bondholder over a specific period of time.

Floating-rate bonds also exist, but are less common. As the name suggests, they have yields that move with a benchmark rate.

Not all bonds pay coupons.

What are bonds and how do coupons work?

Bonds are debt securities, meaning they represent a loan made by an investor to a borrower. The bonds positions typically held in our managed portfolios are in tradable securities issued by governments (government bonds) and companies (corporate bonds).

The income payment is in the form of a ‘coupon’. It is usually made every six months but can also be done monthly, quarterly or yearly. Bond investors normally know the value of the payments they expect to receive and the schedule on which they should receive them (including the final payment returning the initial loan amount).

What is bond yield?

Yield is a way of expressing the bond’s return as an annualised percentage, so that bonds can be compared more easily. There are different ways to calculate yield, and understanding what these mean can be valuable to investors.

Our guide to bonds explains what a bond yield is and also the role that bonds play in a portfolio.

Earning income through multi-asset portfolios

As a general rule, investors prioritising capital growth might allocate more of their portfolio to equities. An investor prioritising income may make greater use of bonds. Multi-asset portfolios provide a mix of bonds and equities, and sometimes other asset classes. 

Blending equities and bonds can help to increase diversification. It is common for investors to hold a mix of equities and bonds to even out periods in which performance in one is weaker. In theory, the prices of bonds and equities have tended to move in opposite directions. It’s called ‘negative correlation’, although the relationship can and has changed over time and is not guaranteed.

In broad terms, this is the case because equities tend to perform well when investors are optimistic about growth. When investors are less optimistic, they may seek out more exposure to (for example) government bonds, because of the greater certainty they can offer in terms of return. There are however numerous examples – particularly when market volatility is high – of this inverse relationship weakening, or unravelling entirely. 

Because the bond yield is dependent on the coupon payments and the current bond price – applying the calculation above – rising bond prices means yields falling. In an environment in which bond yields are falling, it can be harder to maintain income at the same level.

From an overall portfolio perspective, having an additional source of uncorrelated yield – meaning it does not behave the way bonds or equities do – could contribute even more to the stability of the income generated in an income portfolio.

How can I buy income-producing assets?

Investors can build an income-focused portfolio using a range of investment vehicles. The right choice depends on whether you want broad diversification, specific exposures, or a more hands-on approach.

• Income-focused collective investments (such as ETFs and investment trusts) can provide diversified exposure to dividend-paying equities, bonds, or other income-producing assets. Some strategies are designed to prioritise income, some prioritise capital growth, while others focus on total return.
• Multi-asset funds combine equities and bonds (and other asset classes) within a single fund, offering a ready-made mix.
• Direct holdings (selecting individual shares and, in some cases, bonds) can offer more control, but require more monitoring and diversification discipline.

What are the risks of income investing?

Income investing, as with all investing, carries risk. Prioritising income in investing can increase a portfolio’s exposure to certain risks, such as:

Income investing may have tax implications

Tax positions differ from person to person, and it is always worth seeking professional advice if you’re unsure about where you stand. That said, if you are considering an income strategy for your investments there are some general considerations outlined below.

Income generated by investments outside of ‘tax-wrapped’ accounts like a pension or an ISA (including Junior ISAs and Lifetime ISAs), in most cases, will factor into an income tax calculation for the year.

In most cases, investments that sit within one of these types of tax-wrapped accounts are protected from income tax and capital gains tax.

It is important to note that:

• Withdrawals of income from an ISA will, in most cases, not attract income tax.
• Income withdrawn from a pension will, in most cases, factor into an individual’s annual income tax calculation.
• Pension contributions generally attract tax relief on the way in, while ISA contributions come out of taxed income.
• Once income is withdrawn from an ISA, it typically cannot be paid back in without counting towards your ISA subscription limit for that tax year (this doesn’t apply to a flexible ISA which can be replaced within the same tax year).

Income tax versus capital gains tax (CGT)

Those considering investing for income should also note the difference between capital gains and income from a tax perspective.

Most portfolios, as discussed earlier, will generate a combination of capital gains and income (total return).

Capital gains will not factor into a tax calculation unless they are ‘realised’. This means that an asset that has increased in value and has been sold, including when we sell assets to change the allocation of your portfolios.

Gains realised in an ISA or personal pension typically will not attract CGT. Gains realised in general investment accounts (GIAs) may attract CGT. However, gains realised in a GIA will also usually need to exceed an individual’s annual exempt amount to attract a tax bill.

Investors may choose to defer the sale of an asset or could potentially offset a realised capital gain if they have realised losses elsewhere. Please note that tax rules vary by individual status and may change.

For some, the income generated by investments may be all or a large portion of their total income in any given tax year. Others may wish to generate income from an investment portfolio that is in addition to income received by other means, like employment. Income tax can, for many investors, be higher than CGT, which may be an important consideration for investors.

Whatever the circumstance, investors should understand the tax implications of investing for income compared with investing for growth.

Speak to us about investing for income

If you think investing for income might be for you, but want to talk it through first, book a free call with our wealth experts. They can explain how it works in more detail, and how it could work for you.

You can invest with us using our ‘Income investing’ portfolios designed using the expertise of J.P. Morgan Asset Management. To discuss which of our investment styles could be right for your portfolio, book a free call with our wealth experts. We can talk you through how it works, chat about your current investment strategy and answer any questions you have. Just choose a time that works for you.

Risk warning

The longer you stay invested, the more time your money has to grow. Investments, and any income from them, go up and down, so at times you could get back less than you invest. Income isn’t guaranteed. £10,000 minimum investment required for a J.P. Morgan Personal Investing income investment portfolio.

Past performance and forecasts are not a reliable indicator of future performance. We do not provide investment advice in this article. Always do your own research.