Growth investing is usually done during an investor’s high income years while income investing is usually done during retirement, but the best time to transition from growth to income can be unclear.
If you’re wondering when to switch from growth to income investments, the answer depends on several factors including net worth, income sources, wealth strategy, expenses and financial goals.
The traditional retirement plan is to transition from growth to income investments when you no longer have the income to pay for lifestyle expenses, presumably without sacrificing your overall retirement goals.
There are several factors to consider before making the switch from growth to income investments that I’ll share in this post.
This comes from almost 40 years of personally investing in stocks and bonds, and creating income streams for the past 15 years which led to an early retirement. (There are two related videos with important information on income investing so scroll down to watch those.)
What Is the Difference Between Growth and Income Investments?
To briefly clarify before proceeding, the purpose of growth investing is to provide capital gains which builds wealth. On the other hand, the main purpose of income investing is to pay for lifestyle expenses.
This isn’t to say that extra income can’t also be used to build wealth. It can when alternative wealth strategies are used, as covered later in this post. But it’s very unlikely traditional investment income from stocks and bonds will build wealth except from compounding over a decade or more because yields are low.
The Time to Switch from Growth to Income
The most common time to switch from growth to income investing is when retirement begins.
When someone enters retirement a huge portion of their income usually ends unless they have done a good job of setting up income streams before retirement. (You can read more about this in my post entitled How Many Income Streams Should You Have? )
The plan is for income investments to provide a major source of income for retirees. If, however, the investor does not need more income in retirement, he may choose to continue to stay in growth investments.
This allows him to accumulate more wealth. This may be the case for someone with a good pension, a high net worth investor, annuity or other retirement plan.
Alternatively, this could be the situation for an investor that has income from alternative investments such as real estate rentals, covered call writing, residual income from licensing, small business income or a myriad of other alternative income generating assets.
Here is my related post on how to buy assets that generate income.
Taxes Affect When to Switch from Growth to Income
Taxes are the biggest expense many people have so investors will want to carefully consider the tax consequences before making the switch from growth to income investing.
Taxes can be triggered in several ways, including the following situations. As noted several times, it’s best to check with a CPA since tax situations vary greatly among individuals.
I am not a CPA; I just share what I’ve learned from investing, my AFC® training, and from taking the federal income tax course twice.
Taxes on Investment Income
The good thing is that investment income often has tax benefits. For example, as of this writing, the tax rate for qualified dividends is 15% for most investors. But 15% of income is still 15% of dividend income that must be paid in taxes. And some, but not all bond income is fully taxable at an investor’s highest tax rate.
For this reason, it’s important to consider taxes in deciding when to switch from growth to income investing as part of an overall wealth management strategy.
Taxes from the Switch from Growth to Income Investments
If growth assets are help inside a taxable account, an investor will want to check the tax consequences of selling them.
Taxes from Moving Funds from One Account to Another Account Another area to consider regarding taxes is whether moving funds from one account to another will trigger taxes.
Most traditional assets (stocks, bonds, funds) used for growth investing can be held inside the same account as income investments. For example, an investor may simply switch from growth stocks to value stocks that pay dividends. Inside most investment accounts, this is simple.
On the other hand, if an investor wants to move funds out of growth stocks that are owned inside a tax favored account to purchase real estate properties, the tax implications could be a little trickier.
It’s worth asking a CPA before doing anything so the most tax efficient strategy can be used, and any potential taxes are included in the evaluation.
By having more regular taxable income, as is often the case with bond income, or net short term capital gains, you could be thrown into a higher tax bracket.
This is another case where it makes sense to ask a CPA if your taxes will be affected if you move from growth to income investments.
Income Inside Tax Favored Accounts
Would the income generation occur inside an account that you can access without penalty? For example, sometimes I sell covered calls on dividend stocks inside my IRA.
I cannot access that income to pay expenses without penalty. So even if you made the switch from growth to income investments, does your own account structure allow you access to the income without tax consequences?
Here is a video I did on the Pros and Cons of Income Investing.
Is Additional Investment Income Warranted?
While it may seem like the starting point for switching from growth to income investing is really about investment strategy, it’s really first about how much income you need from a practical perspective.
Using less money for lifestyle expenses leaves more money to apply to wealth building. Before making the switch, check all your expenses with the following in mind.
- Expenses align with your life priorities.
- Unnecessary expenses have been eliminated.
- Total expenses include seasonal and extraordinary expenses.
Read more about this in my post How Much Money Do You Need to Retire?
Other Income Sources
Other income sources are a huge factor in the decision to switch from growth to income investments.
Make a list of all income sources you currently have or reliably plan to have. Don’t include small business income that you hope to get, for example. Do include guaranteed income from an annuity, or social security.
Social security is about as close to certain as you can get, at least for decade, according to my CPA. And annuity income depends on the financial stability of the company and the policy.
Do the Math Before the Switch from Growth to Income
Take the income you have or reliably plan to have. Deduct your expenses.
The difference is the income gap that you need to fill. If there is no gap, as addressed earlier, it could make sense to stay in growth investments. (I personally like to consider the economic cycle regarding growth vs income investing as explained more here.)
If there is an income gap that needs to be filled, the following questions can be used as a guide to whether investment income is the best option to fill the gap before making a switch from growth investments which may continue to build wealth.
- How big is the income gap?
- What are the options to fill the income gap?
- Does it make sense to fill that gap with investment income based on the above factors or other factors that apply to your own situation?
- Do you want to work part time for someone else?
- Would working for someone else affect your medical insurance?
- Do you want to start a small business?
- Would investment income be enough to fill the gap?
For example, if you plan to switch half a million dollars from growth to income investments in common stocks and bond investments using a standard asset allocation, the typical income may range from 3 to 3.5% as of this writing.
Using 3%, the income from typical stock and bond investments would be about $1,250 a month before considering fees, taxes and inflation.
After doing the math, many investors see that it makes sense to create one or more income streams before retirement. (Here’s my related post The Best Income Stream to Start before Retirement.)
This is exactly what led us to create multiple income streams which eventually led to completely replacing job income.
Start creating your own financial future with my Ultimate Wealth Plan. You can get it here now.
Here is my video How Much Do I Need to Invest to Make $10,000 a Month. It’s shocking! But keep reading. And here’s my post with several examples of increasing investment income which you’ll want to see if you feel discouraged.
Exact Timing for the Switch from Growth
Many investors who want to retire soon are understandably unsure about exactly when to make the switch from growth investing to income investing.
The type of income investing to be done will be a guide to the timing on when to switch from growth to income.
Moving from growth investments to income investments in stocks and bonds can be done easily and same day in most cases. This is true even with slightly alternative investments such as REITs and MLPs.
Covered calls can be sold on stocks within seconds. Most people invest in stocks and bonds for income since this is the most common method promoted in media. It’s also the most passive income.
Alternative Income Investments
On the other hand, more proactive investors that invest in rental properties or buy or start an online business can wait months or even years before getting ongoing income streams.
This is why it makes sense to start an alternative income stream before retirement. This is particularly true when undervalued assets are bought as covered extensively in my post here.
The Growth Vs Income Investment Strategy
The entire principle of a clear switch from growth to income investments at retirement is being challenged by many new investment strategies as well as income investment disrupters away from the traditional retirement model.
This leaves the question: Do you really need to make a clear switch from growth to income investments?
Many income generating investments can also serve the same purpose of growth investments through capital gains. Here are some examples.
Stocks and Bonds as Both Growth and Income Investments
The availability of financial data and information has given investors the ability to build wealth easier from investments, which was the purpose of growth investing.
With this data, investors can buy undervalued assets that build wealth on the subsequent increase in price back to the norm. This isn’t about market timing.
It’s about using reliable historical information to make investing decisions instead of a cookie cutter approach that ignores market valuations. (This post, Best Assets to Build Wealth, has examples with math, charts of stock market history and explanations.)
This means that income investments, such as dividend stocks, can be growth investments, too, when they are purchased at low valuation with high potential to increase in value.
One of my favorite examples of this is father investing my parent’s hard earned savings into a diversified portfolio of municipal bonds when they were insanely undervalued in the early 1980’s. Not only did they pay up to 25% interest tax free, they were selling at up to 50% discounts.
Online Income Generates Income and Growth
The surge in alternative income investing in small business or real estate lending through online platforms has provided new ways to increase investment income that far exceeds most stock and bond income.
Such income strategies were available only to high net worth investors until recently.
What an incredible change this is from simply buying AT&T or even the Dogs of the Dow to collect dividends. Some of these online investments have the potential to be both growth investments and income investments.
Real Estate for Growth and Income Investments
The popularity of investing in income producing assets, such as real estate rentals, challenges the old model. (After investing through a few real estate cycles, I can say that popularity rises during strong up trending real estate cycles.)
Buying real estate at low valuations will build wealth as valuation increase. This makes undervalued real estate both a growth investment and an income investment.
Online Business for Growth and Income
Buying or starting an online business is an investment in time and money.
And the ability for anyone to start an online business that reaches a global market or offer services worldwide online has also given investors yet another way to significantly increase income that is light years beyond the income generated from owning stocks and bonds.
Speaking from experience, it’s not easy to do, but it can all be done while working part time from anywhere. There has never been a better time to be approaching retirement given all the many ways that diversified income can be generated beyond investment income into stocks and bonds.
These same income generating assets can also serve as growth investments as in the examples above. And it’s a good thing since interest rates have been so low for many years.
When to Switch from Growth to Income Investments Summary
There are many considerations for when to switch from growth to income investments. All investors will want to carefully consider the factors above along with their own lifestyle and financial goals.