Monday 7 February 2011

Focus on Income

The DIY Income Investor approach is - pretty obviously - mainly about income, although safeguarding and growing your capital faster than inflation is also a core consideration. You might need to adjust your mindset to focus on income. How much income do you have now and how much would you need in the future?

The ultimate reason for building up income and wealth is to enjoy it in the future - a long-term aim may be to give up work and to live on your passive income generated by the DIY Income Investor approach.

Monevator has identified a number you need to beat - your current take-home pay: he (I assume it is a he) focuses on growing his passive income to replace his work income. He believes - as I do - that there are some significant psychological and practical benefits in targeting income rather than a capital sum when making your investment plans:
  • It seems more feasible. Dreaming of having £1 million sounds like winning the lottery. Generating and income of £25,000 a year seems more feasible.
  • It helps you to make better investment decisions. If you’re shooting for get-rich-quick schemes, you’re liable to take too many risks and lose money rather than make it. If you’re building a portfolio of income-producing assets, you’ll take a more measured, longer-term view, reinvesting dividends over time and not being scared out by blips in asset prices.
  • It encourages diversified asset allocation. By buying different income producing assets as and when they appear cheap (and it's easy to compare yields), you’ll build up a diversified portfolio as well as buying 'more income bangs for your investment buck'.
  • It is cost-effective - as it is a way to reduce portfolio 'churn', taxes and dealing fees. This is a great hidden benefit. If you buy shares in a company with an 8% dividend yield, you should never need to sell it provided the income keeps coming in (and ideally rises with inflation). That means no extra fees for your brokers, and no capital gains tax (or, in the UK, stamp duty) for the tax man – and so more money for you to compound over the long-term or to spend later.
I would add that also - you can do it yourself!

Another way to look at the focus on income as a way of buying insurance against life changes:  if you were made redundant, would you have enough income to live on? Could you retire early? How early?

I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.

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