Best Way to Make Investment Income?

What is the best way to generate income from your portfolio? If you are on a limited 9 to 5 income, or you are in retirement then this question is a valid one. Here I will discuss a few ways to generate income from your portfolio. However, what I will first way is that it is vital that you do not chase yield i.e. a high dividend. The reason you should not do this is that you will find that the stocks with the highest yields often cannot sustain those yields over time. Their payout ratios might be above 100%, or their stock prices have come down so far (for likely valid reasons) that their yields have gone above 6%. This 6% yield rate is where Jim Cramer says that you should be getting wary about investing in a stock. So you want a sustainable yield with a payout ratio below 100%. This is important to remember when investing in dividend stocks.

One way to generate income from your portfolio is probably the most obvious; invest in stocks with sustainable dividend yields. Examples of this could be BHP on the ASX, Enterprise Products Partners of the NYSE, or Fonterra on the NZX. Remember that I have already discussed why it is unwise to stay away from those stocks with very high yields. In the cases I have mentioned, BHP and Fonterra have sustainable yields basically because they are a large companies that have economies of scale in their markets. Enterprise Products is an oil and gas pipeline operator that has a lot of sunk capital costs, and little direct correlation to the volatile crude oil or natural gas prices. Something to be aware of with this strategy of generating investment income, is that you will be taxed twice. This is true even if your stocks dividends have franking credits, which means that the company will deal with your portion of general income tax before the dividend reaches your bank account. However, this is not the only tax you will pay with dividends, you are also obligated to pay Resident or non-Resident Withholding tax. This will vary upon the total income that you earn. So keep this in mind.

The more tax efficient way to generate investment income is to have companies or ETFs that retain their earnings and generate better capital price appreciation (than high dividend payers), and to just sell a portion of your holding when you require the income. The problem with doing this is if you trade with a full-service broker, you will be charged a high brokerage rate every time you sell. Even if you do your trading online through ANZ or ASB Securities, you will still be charged around $30 every time you sell. The best way to generate income this way is to trade though a fully online broker like Interactive Brokers, Hatch or Sharesies. By doing it through a fully online broker, your commissions when you sell will be small, with Hatch they will be only $3, and with Sharesies even less. A lot of people do not like the volatility of individual shares, so many will choose to own index ETFs like the TWF or USF. Considering that the US Markets have returned 10.5% over time (with dividends reinvested), this is not a bad way to generate income. Much better also with you want to generate an income above the inflation rate. Remember also that this is a very efficient way to generate investment income from a tax perspective, especially in NZ as we do not have a capital gains tax.

If you are in your 20s or 30s, earning a good income from your investments may not seem so important. Keep in mind though, that great wealth can be built by just holding good stocks over time and compounding their capital appreciation. As an example, if you were to invest $1000 in the S&P 500 when you were 20, and held this investment till you were 65 (without even making any additional contributions), this would add up to $110,000 when you are ready to retire. Definitely nothing to sniff at!