Portfolio Income and Financial Independence | Home Finance Help

Portfolio income is just one source of income a personal financial plan can rely on. Over your lifetime, money will be earned in one of three ways.

• Earned Income ? Trading dollars for hours, for example a job at McDonalds.
• Passive Income ? Income from work that has already been completed and takes very little or no work at all to maintain, for example royalties earned today from writing a book five years ago.
• Portfolio Income ? Income from investments, for example earnings from a high interest savings account.

All three types of income can and should be used in your financial plan. The purpose of this page is to help you decide what role portfolio income will have in your financial plan.

Roles of Portfolio Income

Most young investors reinvest their income made from investments because their primary source of income is earned income. Reinvesting has its advantages because the early stages of life are when you want to take advantage of compound interest.

Once you feel the time is right, instead of reinvesting portfolio income you can use it as a primary source of income.

The goal is having your monthly portfolio income be greater than my monthly expenses.

Ways to Earn Money Through Investing

There are three types of income you can receive from investing:

• Appreciation ? Income from selling an investment from a price change.
• Dividends ? Income from the distribution of earnings to shareholders.
• Interest Income ? Income from lending your money.

The following is an overview of each type of portfolio income and its tax consequences.

Appreciation

Many people immediately think appreciation when it comes to making money from their investments. Simply stated, appreciation is selling the investment at a higher price then you paid for it. For example, selling a stock at $20 when you bought it for $10 would result in $10 of income per share.

Once you sell an investment, you either have a long or a short-term capital gain.

A long-term gain is realized after selling an investment that was held for greater than one year. Long-term gains are taxed at either 0% or 15% depending on your tax bracket.

A short-term gain is realized after selling an investment that was held for less than a year. Short-term gains are taxed at ordinary income tax rates, which currently means up to 36%.

Dividends ? Definition of a Dividend

Depending on which type of investment you hold, dividend income can play a major role in your total income. The definition of a dividend is the payment made by a corporation to its shareholders.

Receiving dividends from an investment, isn?t guaranteed. Corporations that pay dividends are typically old and stable companies looking to reward shareholders. Dividends are paid on on a per-share basis, and is adjusted depending on the future direction of the corporation.

Dividends received is either taxed as qualified dividends or unqualified dividends. Qualified dividends are taxed at 0% or 15% depending on your tax bracket. Unqualified dividends are taxed as ordinary income, which can be as high as 36%.

More on Qualified vs. Unqualified dividends.

Interest Income

Most investors are familiar with interest income because they have earned it for many years in their savings accounts. Interest income is earned from lending your money to someone who is willing to pay you for your loan.

Th most popular places you can loan money to and receive interesting are banks, corporations, and the U.S. Government.

The taxing of interest income goes beyond the scope of this page. This is because each type of investment can be taxed in many different ways. Some investments might be taxed at both the federal and state level; some investments might be exempt from one and not the other, while some investments might avoid both. Before making an investment for interest income purposes, always know how it?s taxed.

Financial Independence and Portfolio Income

How would your lifestyle change if your monthly income from investment income was greater than your monthly expenses? This is one way in which you can reach financial independence.

Personally, financial independence is a big goal for me. Every month I track my portfolio and passive income compared to my expenses.

My current investments are not invested for income, but for long-term growth. At the end of each month, I use Vanguard?s Managed Payout Fund Calculator to estimate my expected income I would receive each month if I were to invest for income as my primary goal.

Once my portfolio and passive income sources begin to out gain my expenses, I will have reached my definition of financial freedom.

Source: http://www.thehumblemumble.com/portfolio-income-and-financial-independence/

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