Work-Free Wealth

Income Investing for Financial Independence and Early Retirement

Getting Started

Getting Started
Feeling intimidated? It is understandable with all the overload of information out there, so here is a path to how you could get started.
There are two aspects to this: getting started with investing or getting started with income investing. If you have not been investing at all, then just focus on overall investing and growing your savings. This part is straightforward:
First of all, let’s be clear why it is so important to get started with investing in general and investing in stocks or stock funds in particular. Stocks give you the best long-term return of any investment. Sure, they are volatile, so buckle up and be sure to ride out the bumps in the road. Take a look at the following chart if you need convincing:

Source: Fidelity Viewpoints “Why you need stocks”

Once you convinced yourself that investing is the best way to put your money to work long-term, you can choose an investment.  A total market index fund from any large brokerage firm gives you exposure to all the publicly traded US companies.  Here are three funds that have super-low expense ratios:

  • iSHARES CORE S&P TOTAL US STOCK MARKET (ITOT), expense ratio 0.03%
  • VANGUARD TOTAL STOCK MARKET ETF (VTI), expense ratio 0.04%
  • SCHWAB US BROAD MARKET (SCHB), expense ratio 0.03%

This is the Vanguard founder’s Jack Bogle’s approach to investing since it is focused on the entire US stock market and assumes you get enough international exposure.  If you rather add maybe 10% or 20% international exposure, you can choose a low-cost international fund like VANGUARD TOTAL INTERNATIONAL STOCK (VXUS, 0.11% expense ratio) and an Emerging Market fund like VANGUARD FTSE EMERGING MARKETS (VWO, expense ratio 0.14%).


Shifting to income investing

You may already be well-versed in investing and have grown your portfolio to a point where you would like to shift to an income focus.  Now you are ready to let your money provide you with an income so you can live the financially independent or retired life.  Treating your portfolio like big pot of money to sell shares as needed is a very dangerous approach.  It goes against the nature of most savers who got to this point to sell any principal.  Living of your dividends and interest while letting the principal grow may sound like something your grandma told you, but it still works.  It is also a very good approach to sleep well at night.  Getting to a high enough income by just investing in the broad market ETFs mentioned above will not provide a very high yield.  Switching from a growth focused portfolio to an income focused portfolio means having to learn a bit more about investments.  I go over 11 different income investing strategies in my book “Work-Free Wealth” but you certainly don’t need to use all or even half of them.  Here is the way that I suggest as a good start to diversify into some higher income vehicles:

-Switch out some of your total market index fund for a dividend growth fund. There are some good dividend focused funds that grow very nicely and throw off a growing dividend stream every year.  Some examples here would be VYM and SCHD

-Add some preferred stocks or a preferred stock fund. Individual Preferred Stocks have the advantage that you have better control over what you invest in and can pick them when they trade below par value (the price that you get when they are redeemed).  To keep it simple, you can always choose a fund instead.  iShares Preferred Stock ETF (PFF) is one of the largest, but there a several available to choose from.   The expense ratio for preferred funds is a bit higher than for other ETFs.  PFF’s expense ratio is currently 0.47

-Invest in some real estate, REITs to be specific. To get started, you can just pick a REIT ETF unless you are inclined to seek out good individual REITs of which there are many.  Vanguard’s REIT Index fund (VNQ) is a good option with a 0.12% expense ratio.

The individual allocation to each of these categories depends on your income needs.  I would keep 50% in dividend growth stocks just to make sure you don’t miss out on nice bull markets and split the rest.


Account types:

You can start withdrawing penalty-free from your tax-advantaged accounts if you are at least 59 ½.  That opens another avenue of strategic asset allocation.  In that case, you can place your higher yielding assets that pay interest or non-qualified dividends in your IRA and your qualified dividend paying stocks and funds into your taxable brokerage.  Anything you withdraw from your traditional IRA will be taxed as ordinary income anyway so you can keep your taxable account for the qualified dividends.  A ROTH IRA will allow you even more flexibility.  Since you already paid taxes on your money going into the ROTH, you can withdraw tax-free from it.    I would withdraw just enough from the ROTH to keep in a lower tax bracket and meet expenses and let the rest grow.  The ROTH IRA is not subject to minimum withdrawal requirement when your reach 70 ½ which is another great benefit.