Personally, I love income investing strategies that can generate stable income for me. What I love even more is income investing strategies that can produce income on a monthly basis.
Most of my bills need to be paid every month.
Phone bill. Utilities bill. Cable bill…
Most of you already know that I quit my job and kissed goodbye to my monthly paycheck a couple of years ago.
So, I had to create new income streams to cover my monthly living expenses and pay all my bills.
Ideally, it could generate consistent monthly income.
Investing was such an income stream.
What Is Income Investing?
Income investing refer to a method of investing that aims to generate cash flow from your investments such as stocks, bonds and real estate.
Common Income Investing Strategy
Let’s first look at some of the common income investing strategies.
Investing in dividend stocks is a very popular investing strategy. The underlying company usually has a long history of paying out consistent dividends.
Depending on the dividend policy of the underlying companies, these companies generally pay out dividends once or twice a year.
However, it’s not guaranteed that dividends will be paid out every year. The underlying company can decide when and how much to pay.
When you buy bonds, you are essentially making a loan to the bond issuer.
Depending on the terms of the bonds issued, you might get an interest payment semiannually or annually.
But, the minimum investment amount for bonds is generally quite large. So, it’s not realistic for retail investors to invest in bonds.
Having said that, there is another way for you to invest in bonds with less capital.
The good thing about bond mutual funds or ETFs is that they produce a monthly income.
Rental property is another popular income investing strategy.
How it works is very simple.
You buy a rental property, lease it out and collect rental every month.
As we are looking for decent monthly investment income, buying a rental property using a mortgage loan does not really help us achieve our goal.
Yes, it’s possible for you to find a rental property that generates positive cash flow every month even after mortgage payments.
You might think that your cash flow would double, triple, quadruple or n-tuple if you could find more deals like this.
No doubt that’s a smart idea.
But, the risk you are taking with multiple rental properties will increase substantially in a rising interest rate environment.
When your mortgage payment exceeds your rental income, your positive cash flow would turn into negative cash flow.
And we are not yet even talking about the possibility that the value of the properties could go down.
So, rental income is nice if you have the cash to pay for the rental property in full.
Real estate investment trust is a good alternative to rental property.
REITs, a real estate investment trust (REIT), is a company that owns, and in most cases operates, income-producing real estate.
Many REITs are publicly listed on exchanged where you can buy and sell easily, just like stocks.
Legally, REITs are required to maintain a payout ratio of at least 90%. Many have dividend yield that is in excess of 10%.
Here are some advantages for investing in REITs for income:
First, it’s a much more liquid investment if you compare it to buying the actual property. Also, it’s not as capital intensive.
Second, it gives you exposure to different types of commercial real estate such as shopping malls, hospitals and offices.
Third, you get dividend payouts on a quarterly basis.
My Income Investing Strategy
But, here’s the problem.
Although fully paid-up rental property with monthly rental income would be the most ideal, I don’t have so much capital to proceed.
Other income investing strategies such as dividend stock investing, bond investing and REITs investing don’t promise a consistent monthly income.
My search for monthly investing income led to this – Cashflow Investing Strategy.
How this works is that we sell PUT options on high quality and attractively valued stocks to generate consistent monthly income at NO ADDITIONAL RISK. (I will explain this later on)
So first, what are options?
“An option is a contract agreement which gives the buyer the right to buy or sell a financial asset at an agreed-upon price. We call this agreed price Strike price.”
There are two types of options:
- Call option – it gives the option holder the right to buy at Strike price.
- Put option – it gives the option holder the right to sell at Strike price.
In our Cashflow Investing Strategy, we are ALWAYS options sellers.
When we sell options, we collect PREMIUM from the option buyer upfront.
Premium is the amount of money that the options buyer has to pay to purchase the option. Premium is usually a small percentage of the stock price.
Are Options Very Risky ?
To many people, they feel that trading options is very risky and difficult.
But, did you know that Warren Buffett, a conservative investor, sold PUT options to boost his investment returns?
Yes, he also uses options.
Options are just a tool that he uses to buy the stock he wants at the price he wants.
Let me give you an analogy.
For example, we want to go from point A to point B.
There are a lot of ways we can do it.
We can take bus.
We can ride our bicycle.
We can take a taxi.
Bus, taxi and bicycle are just vehicles that can help us get to where you want to go.
Similarly, options are just a tool that we use to help us buy stocks at our target buy price and sell stocks at our target sell price.
Stock investing by itself is risky, just like all the other types of investments out there.
When you buy a stock, the stock price can go up or down.
It’s possible that the stock price can stay at a depressed level for a prolonged period of time.
Similarly, it could also stay at an elevated level for a long period of time.
As no one can predict where the price will go in the future, what matters most is how you manage your risk.
Now, let say the stock price is $10 and you want to buy the stock at $10 right now.
What you can also do is to sell a PUT option with a strike price of $10. (Let’s leave out option expiration date for simplicity’s sake)
Scenario A: If the stock goes up to $11, you keep the money you make from selling the options without having to put up a lot of money to own the actual stocks at all.
Scenario B: If the stock price drops to $9, you lose less money as holding the stock itself.
When the stock price goes down to $9, you are obligated to buy the stock at $10.
But, the premiums you earned from selling PUT options can be used to reduce your cost price.
That’s why it’s always better to sell PUT options at NO ADDITIONAL RISK or even less risk.
The only downside is that you will not enjoy the potential upside if the stock price suddenly shoots up substantially within a short period of time. But, the probability of such things happening is generally quite low.
How Cashflow Investing Strategy Works
For our strategy, we incorporate the principles of value investing in selecting the stocks we want to sell options on.
We all know that value investing is all about buying good businesses for less than its intrinsic value.
And it’s a proven high return and low risk investment strategy.
First, we use value investing principles to find high quality stocks at attractively valued price.
Next, we want to make sure that the stock price has a low possibility of going down or going down by much in the near term, from a technical analysis point of view.
Then, we will start selling PUT options in the short term at a strike price that is near the market price.
Now, there are two things that might happen:
Possibility #1: Options expire worthless.
Options will expire worthless if the stock price stays above the strike price at expiration date.
This is the scenario that we like the most. When options expire worthless, we get to keep the premiums for free.
If the stock price still stays near and above the strike price, we can continue to sell PUT options to get paid month after month.
But, if the stock price goes up by a lot, we will move on to our next target to sell PUT options on.
Possibility #2: Options are exercised.
Options will be exercised if the stock price goes below the strike price at expiration date.
So, what happens when the options get exercised?
You have to buy the stocks at the strike price.
What you do next is to start selling CALL options on your stock holdings to help yourself get out of your position at a profit or at break-even price.
By repeating this process over and over again, we should be able to create a steady pay cheque for ourselves month after month safely and simply.