True financial independence is being able to live off investment income without spending down your investment capital.
How to calculate investment income: Multiply investment cost by the yield to get the amount of annual income. For example, if an investment that costs $100,000 yields 3%, investment income will be $3,000 a year.
After calculating investment income, however, there are a few factors that will affect how much of your investment income you’ll get to keep at the end of the day.
There are also timing factors that will affect your ability to conveniently live off investment income after you calculate just how much investment income you’ll make.
In this post, I’ll share:
- 4 crucial but overlooked factors for calculating investment income accurately
- How to compare investment income for various income generating assets
- A common mistake investors make when calculating investment income
- A shortcut for seeing how much investment income you’re getting now
- A serious risk many income investors don’t realize
While I’m an AFC® (Accredited Financial Counselor) the information in this post was learned from creating investment income streams over the past 23 years as well as my work as a financial coach and investing course instructor helping others assess and establish income streams before retirement.
Click to Open Table of Contents >>>>>
How to Calculate Investment Yield
Investment income is most often expressed as yield. This means that if your goal is investment income vs capital gains, knowing the investment yield is important because it allows you to compare income investments easier. Sometimes yield isn’t widely published, though, so let’s work backward from the simple formula above.
Investment yield is calculated by dividing the dollar amount of income you get from an investment by the amount you paid for that investment.
While most investors still think of bonds as the main type of income investment in a portfolio, many investors have turned to dividend investing for income over recent years since real bond yield is still relatively low, if not negative.
For this reason, we’ll start with a dividend example to calculate investment yield.
Dividend/Cost = Investment Yield
For example, if you invested $10,000 in the stock of Income Inc, and Income Inc paid a 3% dividend yield, your investment income would be $300 a year.
Note that the yield will be widely published for most investments based on current market value.
Resource for Calculating Investment Income
This Investment Income Calculator from Vanguard is a simple tool to calculate investment income on a given amount of capital. You’ll want to consider the other factors in this post, however, beyond the initial math.
Evaluating Investment Income
Here’s a tip when using the yield for evaluating income investments: Look at investment income from a dollar perspective, not only as a percentage as yield is stated.
By looking at the dollar amount vs just a percent that you’ll get from an investment, you can put the value of that investment income into better perspective when it comes to paying for lifestyle expenses.
Let’s do that with the stock dividend example from above that provided a 3% yield, or $300 a year, or $25 a month.
Using $10,000 of capital to get investment income of only $25 a month, however, is not too enticing, especially when there is risk that the value of the stock might go down in price after you buy it! It takes a lot of $300 yields to support a lifestyle for most people.
Of course, the stock may increase in price instead of dropping, thereby providing both dividend income and a capital gain. That’s what stock investors hope to get.
Next, let’s explore the factors that affect when and how much income you get to keep after the initial investment income calculation.
Factors That Affect Investment Income
Do you get to keep the full $25 a month that comes in the form of investment income as in the example?
Unfortunately, you may not. There are a few factors that affect investment income calculations for when or how much investment income you get to keep.
|Inflation||Value of Investment Income|
Investment Income from Stocks
Let’s address each of the factors that affect investment income in the table above in relation to investment income from stocks, specifically, before moving into bond income.
Timing – Annual Dividends Vs Quarterly Dividends
Most stocks pay quarterly dividends and not annual dividends, making cash flow tricky during many months for investors living off dividends. Here are two timing tips for dividend investors.
- Make sure you’re dividing the annual yield by 12 when calculating monthly investment income, even though it is received quarterly. This is because most of us think of monthly spending when looking to cover expenses from investment income.
- Most companies tend to pay dividends the same months as other companies pay dividends, so it’s important to consider this when calculating monthly investment income if you’re trying to live off stock dividends. You may have some months without any dividends whatsoever!
Taxes on Dividend Income
Dividends are typically subject to federal income taxes in the U.S. Qualified dividend income does, however, get a lower tax rate than earned income as of this writing.
Even though the taxes probably won’t be deducted before receiving the dividends, taxes will likely need to be paid on them by the correct time.
You can only get a true comparison among various types of income generating assets by considering after tax income. While the lower dividend tax rate on qualified dividends is helpful, many other income investments have tax related benefits that can have a greater impact than simply a potentially lower tax rate.
Therefore, owed taxes must be part of your final investment income calculation so you can compare and evaluate investments bought for income.
Investment Income from Bonds
Let’s move to investment income from bonds to see what factors might affect the income calculation.
How to Calculate Investment Income from Bonds
Income from individual bonds is calculated in the same way that investment income is calculated for stocks.
While the math is the same, note that the income you get from bonds is in the form of interest and not dividends. Interest and dividends almost always have different tax rates.
When Do Bonds Pay Interest?
Investment income from bond interest can be even trickier to plan cash flow around than stock dividends. This is because some bonds pay interest only twice a year.
Many bonds that are owned outright, such as EE Series bonds, pay interest when the bonds are redeemed. Bond funds may, however, often pay monthly income, and this is how most investors own bonds in their portfolio nowadays.
The type of bonds you own, and the form in which you own them determines when you will be paid bond interest, as you can see.
Are Taxes Owed on Bond Interest?
You’ll want to consider taxes when calculating investment income from bonds, too. As of this writing, most bond income, when applicable, is taxed as ordinary income. This can result in higher investment income tax rates than that of stock dividends.
Whether or not a bond is subject to income tax depends on the type of bond it is. For example, some investors buy municipal bonds to avoid taxes on bond income.
Note that the tax rules can also vary for federal income tax vs state income tax.
Note that if you have bought a mutual bond (or stock) fund for an income investment, you may incur a capital gain or loss within the fund itself. Then you could also have a capital gain or loss from buying and selling the fund.
Estimating the tax expense in the evaluation phase for bond income can, admittedly, get tricky but you can research this, ask a CPA or a financial planner; some of these professionals are available at hourly rates for quick questions like this.
Many investors forget to consider taxes when calculating investment income and comparing income investments yet taxes can eat into the income investors get to keep.
Are Fees Deducted from Investment Income before It’s Paid?
Many investors buy funds instead of individual securities. The investment income calculation for funds is the same as it is for stocks and bonds but there is yet another hidden factor.
Like taxes, you may not see the fees when you receive fund investment income whether it’s from derived from stock dividends or bond interest.
Fees can range from less than about .05% to an expensive 3% or more per year so you’ll want to consider this in getting a true investment income calculation if the published yield excludes fees.
Sometimes there are even layers of fees when investing, such as various types of fund fees and wealth management fees.
It is important to note that often, however, the yield for a fund is often expressed as “net of fees”. This means that fees are already taken out of the yield but you’ll want to make sure before calculating the final investment income from a fund.
Does Inflation Affect Investment Income?
Inflation is often forgotten as part of the investment income calculation since inflation is published outside of the investment itself, and there is nothing paid for inflation.
Inflation isn’t a “what if” scenario. Inflation has existed almost every single year for the past few decades. I recall my father, ever the teacher, emphasizing the importance of considering inflation in considering investment income after it rose to over 13% in the early 1980’s!
Even if inflation stays low, over time the effects of inflation compound, making it a very serious threat for those trying to live off investment income. Therefore, investors will want to account for inflation with an estimate for future inflation in real investment income calculations.
The reason inflation must be considered when calculating investment income is because it makes the income received worth less.
Investment return after inflation is referred to as “real return”.
Certain investments, such as TIPS bonds or an alternative investment like real estate are considered inflation hedges since the investment income from both of these inflation defensive assets can often maintain their purchasing despite inflation.
You can get the current rate of inflation here to calculate real investment return; you may be shocked by what you see.
How Can I See My Investment Income Quickly?
The fastest way to see investment income you’ve already earned is by checking your brokerage account or statement.
The total income year to date will be shown on most statements. You’ll also note various posts to your account from dividends and interest as they are paid during the month.
Online tools at your broker make this easy to see. You can also sort activity by dividends or interest at your brokerage firm, and then download the activity to a spreadsheet.
Of course, this information is for past investment income. If you haven’t had a lot of changes in your portfolio, or there haven’t been major economic changes, you can usually check the prior year’s investment income off your broker’s year end statement for a good estimate to use the following year.
Remember, however, that investment income changes from year to year, if not month to month, for almost all portfolios. For example, the income from money market accounts can change daily; companies regularly change the dividends paid out to shareholders.
Is Investment Income Based on Cost or Market Value?
A common mistake investors make when calculating investment income for an investment they own already is using the current market value instead of their cost in the calculation when re-evaluating an investment previously purchased.
Let’s say you bought an investment for $100,000 that was yielding 5%, or $5,000 investment income a year.
The investment price then rose to $200,000. If you calculated investment income using a market value of $200,000, your yield would be only 2.5%, which is incorrect. Investment income is based on the cost for investments you own already, not market price.
Say the same investment decreases in price to $50,000 and continues to pay $5,000 a year income. You would get an incorrect yield of 10% for your investment if you calculated investment return using the market price vs your cost of $100,000.
Your investment cost determines the income yield, not market value.
Portfolio Investment Income
It can be helpful to calculate portfolio investment income vs income from a single investment. If a million dollar retirement account yields 4% overall, for example, the amount of investment income would be $40,000 a year.
To see investment income from your portfolio as a whole, simply gather the amounts of investment income you’ve received from all sources, and organize them onto a spreadsheet. That is assuming you have investments in more than one place, as most older investors do.
While many investors consolidate their investments online now, having this information in a spreadsheet will provide an excellent analysis tool for various income generating assets while considering the related factors presented here, such as taxes and inflation.
Investment Income from Alternative Investments
It’s simple enough to calculate investment income from traditional investments like stocks and bonds, especially if income hasn’t been reinvested.
But it’s more complex to calculate investment income from the alternative investments I sometimes write about here which more advanced investors use, such as covered call strategies, business or real estate investing.
The bottom line, however, when calculating investment income from any asset is knowing the net amount received by you after all related expenses.
Just take it step by step, then; start with the amount of income you’re getting and consider each of the factors addressed in this post. It’s fairly simple to calculate investment income from covered calls, but real estate and small business income will have many more related expenses.
How to Get Higher Investment Income
Are you unhappy with the amount of income you’ll get from investments now that you’ve calculated it?
You might enjoy my video below on how to get higher investment income.
Summary for Investment Income Calculation
Now you know how to calculate investment income for stocks and bonds, and several important factors that will affect that income.
After you’ve calculated all your investment income, the next step is to begin increasing it, unless, of course, you’re happy with the amount of investment income you’re receiving. If you are, you’ve achieved financial independence in my book so congratulations.
Are bonds safe for investment income in retirement?
Bonds are thought to be a safe source of retirement income while also serving to reduce portfolio risk.
Bond risk increases significantly when interest rates rise, however, since investors can get a higher yield from newer bonds, forcing existing bonds to decrease in value.
As a result, the bonds held by investors can absolutely decline in price, just like stocks or most other income investments can do. The consolation can be that the investment income should continue for bonds issued by quality companies or entities.
Nevertheless, it can be difficult for a retiree, in particular, to see a drop in their overall net worth so late in life, and this is exactly what happens when investment values decline. This is why it’s so important to consider the overall interest rate cycle when investing in bonds, and a portfolio strategy that can weather changes in that cycle very well.
Do most retirees want investment income or capital gains?
Most retired investors are seeking bond interest or dividend income vs capital gains. In other words, they’re usually beyond the accumulation or wealth building phase and looking for ways to live off investment income during or even when preparing for retirement later in their 50’s or 60’s.
Having written this, one of the core principles at Retire Certain is there is no reason not to build wealth in retirement given the many benefits of a bigger nest egg, despite the culture that ignore this possibility. Ideally, investments will increase in price while also generating income in retirement.
If you throw in some tax benefits, in addition to income and capital gain potential, you’ve got a “triple wealth builder” as I call it in my wealth plan.
Do stock dividend funds pay monthly, quarterly, or annually?
Many dividend income focused stock funds pay monthly dividends to make cash flow smoother for income investors. Check the website of the company sponsoring the fund to see the payout.
How to calculate investment income from capital gains
Technically, capital gains are one good thing, and investment income is a different good thing. Each is handled differently for tax purposes.
Many investors consider capital gains as a form of investment income, however.
Leaving the proper semantics aside, you can calculate the “investment income” from a capital gain (as many investors consider it) by dividing the gain by the cost of the investment. I deduct any true income I have gotten from that investment, such as dividends or interest, from my initial cost when doing this, since the income reduces my basis or investment cost, in effect.
How to estimate future capital gains from investments
A related questions is how to estimate future capital gains from investments.
Logically, someone planning to retire needs to estimate their ability to make retirement withdrawals, if, like most people, there isn’t enough capital or investment income to cover living expenses. This leads to the need to estimate future capital gains from investments in addition to investment income.
The reality is that capital gains cannot be calculated with any degree of certainty. Investment income is much more predictable than projected capital gains are.
Having clarified this, I will add that if you need to estimate future capital gains, as most investors do when planning for retirement, I would do so with a consideration of:
- How the current investment strategy you’re using will perform during different economic situations (because this is a certainty: things change)
- The current economy
- The probable future economic environment
I get that this may sound complicated but the truth is that macro factors drive investment returns, not picking the right stock or asset allocation, as I teach in my course How to Retire When You Want and Fund Your Desired Lifestyle. (I’m not trying to pitch you as much as I’m sharing what I’ve learned to be true about investing over 4 decades:)
Investing isn’t as simple as many make it out to be with overly simplified asset allocation into stocks and bonds.