The Three Types of Investment Income and the Impact on your Wealth

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As an investor in the traditional investment space, you will be exposed to the possibility of 3 different kinds of income.

These are; interest income, dividend income, and last but not least, passive income. interest income and dividend income are classified as portfolio income, as the income is derived from traditional securities such as bonds and stocks.

Bonds generate income from “coupon” payments while stocks generate dividends and capital gains.

Generally, interest is paid by fixed income instruments and these can come in the form of bonds, repurchase agreements, and commercial notes.

Dividends, on the other hand, are paid by ordinary and preferred shares and in Jamaica, these may be denominated in Jamaican dollars or US dollars on the Jamaican Stock Exchange.

Ordinary shares are the typical type of stock that people think of when they hear the word stocks, shares or equities, of course, these are one and the same. However, preferred shares provide an investor with a more predictable and quantifiable flow of investment income when compared to an ordinary share.

Examples of Preferred Shares are JMMB Group Limited’s 7.25% and 7.50% shares that are traded on the Jamaica Stock Exchange. The numbers in the ticker  “JMMBGL7.25” as seen on the stock exchange represent the dividend payment which is made on the nominal amount of the security owned and also represents the percentage income that will be received from the ownership of that preferred share.

Ordinary shares pay income in the form of dividends also, however, these are not as predictable as preferred shares dividends, which tend to be a fixed amount and are paid on a fixed schedule. Examples of Ordinary shares which pay regular dividends are Apple, Scotia Group Jamaica, Carreras limited amongst others. One should keep in mind however that dividends are paid from the profits of a companies operations. Therefore if a company is not performing as expected, the companies management may decide to not pay a dividend.

Bond income on the other hand is paid mostly on a semi-annual basis and to a lesser extent on a quarterly basis. The “coupon” is what represents the income in this case. Investors tend to gravitate to hard currency bonds, which are mostly denominated in the US Currency.

Examples of these bonds are the Government of Jamaica’s 8% 2039 Bond or the Dominican Republics’ suite of bonds which have various coupon rates. The “8%”

In the latter represents the coupon and also the income component of a bond investment.

Even though both these bonds represent 2 Caribbean countries, they are denominated in US dollars, as the currency is seen as the world’s “reserve currency” and hence the best store of value.

What we should never forget though, is that income is one of the main reasons why we invest, we want our money to grow and hence our wealth and this leads me to the third type of income; Passive income.

Passive income comes from a venture in which you are not actively involved. That can be rental income from real estate, royalties earned from a book, or other intellectual property, such as music. It also includes income from a business in which you aren’t actively involved, but have a stake in, such as an investment partnership.

Having a flow of growing, consistent income over a long period of time will allow one to grow their wealth. This is a marathon, not a sprint and you should approach it as such.

Discipline with reinvesting investment income over time will lead to compounding, one of the most powerful forces in investing and wealth creation. This is where your interest income itself starts to generate interest i.e.  “Interest earning interest”. The act of reinvesting income consistently over a long period of time will grow your financial assets year over year through this method.

To help you to understand the concept even more, just visualize a snowball rolling down a hill, growing ever larger by every meter as it descends the hill, the growing snowball represents the effect of reinvesting income and creating that compounding effect on your initial investment. The length of the hill is the time you stay invested, the longer the better. Therefore, the more income you reinvest over a lifetime the more wealth you will create once you are investing properly.

This is a major key in wealth creation. Slowly but surely, however, a disciplined and resourceful investor will grow their wealth once income and the reinvestment of said income are done on a consistent basis.

And just a reminder, Wealth Creation is a marathon and not a sprint.