Sunday, October 24, 2010

Three streams of income

TheMoneyMadam’s strategy for creating steady, ever increasing income from investments uses stock and bond investments.

Once you convince yourself that at least part of your invested money needs to create income, you should seriously consider my strategy.

Three income streams are all you need to create steady, ever increasing income.  

One income stream is dividends.  Always buy stock in a company that pays a dividend. Make sure the dividend per share is greater than the company earns per share.  My monthly cash flow, money I need to pay my basic bills, comes from companies with at least a 3percent dividend yield.  Moreover, I select companies that have a history of increasing the dividend every year.   

I recommend companies with a strong balance sheet.  A strong balance sheet means the company has little or no debt and will continue to pay the dividend and increase the dividend over time.
My second income stream is interest from bonds.   Buying a bond means you lend your money to a company or a government.  Although currently bonds are quite expensive, you can still find a few bonds yielding enough to supplement your cash flow and give you some risk diversification.  Buy bonds of the same companies you research for dividend income. However, always buy your bonds at par which is usually $100 per bond or preferably at a discount. Never put all your eggs in one basket.  Buy multiple bonds with varied maturities for instance one bond might mature in 3 years, another in 5 years, and another in 7years.   This spreading out of the bond maturities is called “laddering” bonds.

For investors with high taxable income and or investors who have their savings in non-retirement accounts, buying the bonds of a government particularly of a state, county or city is a good option.  Like a corporate bond, you want to lend your money to an entity that is highly likely to pay you back.  Look for insured municipal bonds or bonds from states like Indiana or Texas.  These states are in better financial shape than California.

My third income stream comes from an option strategy referred to as “selling covered calls” or sometimes referred to as “writing covered calls.”  When you own at least100 shares of a company, that company has a good story, and good growth potential,another stock buyer may want to buy it from you at a set price called the strike price.  They think the stock price is going to be higher in the future than it is when they pay you for the call option.   You sell to someone the right to buy your stock at a set price over a period of time.  They pay you for this right.  If your stock’s price is greater than the strike price, the buyer of the call will exercise their option to buy your stock.  As long as the strike price is higher than you paid for the stock, you make income from the call option and from the capital gain.  I recommend selling calls that expire in 90 days or less. If the price of your stock is equal to or less than the stock price, the option expires and you still own the stock.  You pocketed the income from the call and if you selected your stock carefully, you still own a solid company that pays a dividend while you wait for the next chance to buy a stock.  
I have a blog post on IBM that illustrates the way this works.

These three income streams can create steady, ever increasing investment income. 
Check in often as I continue to teach about these income streams and give recommendations on stocks, bonds and covered calls.

Very Truly Yours,