What Are Income-Producing Assets And How Do They Work?

Want to build long-term wealth? Then you may want to invest in income-producing assets that generate regular income. The more income-producing assets you own, the faster you can reinvest your returns and reach financial freedom. Read on to learn how!

What Are Income-Producing Assets?

An income-producing asset is an investment that generates passive income, such as mutual funds, bonds, annuities, CDs, and real estate. An income-producing asset can help diversify your investment portfolio while producing steady earnings.

What makes income-producing assets so valuable is their ability to produce passive income, i.e. recurring income that takes little to no work on your part. Unlike a job, where you must show up and work to get paid, passive income sources work for you — even when you’re sleeping.

Pros And Cons Of Income-Producing Assets

There are many different types of income-producing assets, each with its own advantages and disadvantages:

The right income-producing assets for you will depend on your financial situation and goals, but to achieve a favorable asset allocation, it’s best to invest in a variety of them.

Best Income-Producing Assets To Consider

Now that you’re familiar with some of the income-producing assets out there, let’s dive deeper into what each has to offer.

Stocks And Equities

Stocks and equities represent ownership stakes in companies. While stocks refer specifically to interests in publicly traded companies, equity is a broader term that can also include ownership in partnerships, mutual funds, and other investments.

Here’s a breakdown of three types of stocks and equities:

Stock Shares

Stock shares return money in two ways: regular dividends and value appreciation. For example, when you own a stock that pays dividends (aka a dividend stock), you earn a percentage of its underlying profits. You also benefit from any appreciation. If the company (and your stock share by extension) has increased in value by the time you sell, you’ll reap additional profit.  

However, stock values can be relatively volatile, especially in the short term. They’re affected by not only company performance and economic trends but shifting investor sentiment, which often has nothing to do with the viability of the actual business. To minimize your risk and maximize your potential return, you must study how to invest in stocks.

Mutual Funds

Mutual funds are portfolios of stocks run by professional managers. As an investor, you gain part-ownership of all the underlying assets in the fund. Essentially, you’re pooling your money with many other investors to gain exposure to a diversified set of stocks. That way, you’re not putting all your eggs in one basket. If one stock in the fund performs poorly, it won’t devastate your position because it only represents a fraction of your overall investment. 

By the same token, if a stock in the fund performs well, it won’t lift your position as high as if you’d invested exclusively in that stock. Consequently, while mutual funds are less volatile than individual stocks, their potential return is more limited.

Money Market Funds

A money market fund is a type of mutual fund that invests in short-term, low-risk securities such as Treasury bills, certificates of deposit (CDs), and commercial paper. Not to be confused with money market accounts (a type of interest-bearing savings account), money market funds sell shares to investors who can earn modest returns.

Since money market funds are required to purchase securities with maturities of 13 months or less (with some exceptions) and maintain a weighted average maturity of 60 days, they are intended as short-term investments. Typically, investors can withdraw their money at any time, though they may be limited to a certain number of withdrawals per month.

Government-Issued Maturities

To raise funds, the federal government sells fixed-income securities in the form of Treasury bills, notes, and bonds. Investors who buy them can receive the security’s face value upon maturity as well as any interest payments. And since Treasury securities are backed by the U.S. government, they’re one of the safest investments available.

Treasury Bills

Treasury bills (aka T-Bills) are short-term securities with maturities of 4 weeks to a year. Typically, investors buy T-bills at a discount, and any difference between the purchase cost and the maturity value is considered profit.

For example, an investor might buy a Treasury bill with a $1,000 face value for $950. At maturity, the investor will receive $1,000 — or $50 more than their initial investment.

Like all government-backed securities, T-bills are relatively safe. If the U.S. government were to default on this debt, you’d likely have larger economic worries. Overall, the safety provided by T-bills means they tend to offer lower returns than riskier investments.

Keep in mind that T-bills can also be sold before they mature on the secondary market, where their value fluctuates with current interest rates.

Treasury Notes

Treasury Notes are medium-term securities with maturities of 2 – 10 years. Unlike T-bills, T-notes pay interest every 6 months until they mature (in addition to their face value at maturity).

Every month, the U.S. Treasury auctions T-notes in $100 increments. According to TreasuryDirect.gov, as of March 18, 2024, 10-year T-notes offer a 4% interest rate. However, their rate and face value aren’t fixed till auction.

The benefits and drawbacks of T-notes are largely the same as those for T-bills. However,
T-bills tend to offer higher returns since they tie up your money for longer.

Treasury Bonds

Treasury bonds are long-term securities with maturities of 20 – 30 years. Like T-notes, they offer investors their face value at maturity plus interest every 6 months. Investors can also trade them on the secondary market after 45 days. However, a bond’s face value is only guaranteed if it’s held to maturity, meaning you may lose money if you’re forced to liquidate earlier.

Of course, with longer terms come higher potential rewards. Of all Treasury securities, T-bonds tend to have the highest yields.

Annuities

An annuity is a financial product, by which an investor pays a lump sum or multiple payments to an insurance company in exchange for a regular income immediately or in the future. It’s a popular investment tool among retirees because it offers a fixed income for life or a set period, thereby mitigating the risk of outliving one’s savings.

Another benefit of annuities is that contributions grow tax-free. You only owe taxes on withdrawals. Plus, there aren’t any contribution limits as with other retirement tools, such as individual retirement accounts (IRAs).

On the flip side, annuities are relatively illiquid. You can’t withdraw early without penalty. In addition, most annuities come with management fees.

CDs

A certificate of deposit (CD) is a type of savings account that lets you deposit money for a fixed period to earn interest at a fixed rate. Most banks and credit unions offer them for terms anywhere from 3 months to 5 years. The longer the maturity, the higher the interest rate.

Furthermore, CD interest rates tend to be higher than those for regular savings or money market accounts, while still being insured for up to $250,000 by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA).

Of course, CDs also tie up your money for a set period. While early withdrawal is possible, it comes at the price of a hefty penalty. But overall, CDs can be a good choice if you’re looking for a safe and steady income source.

Real Estate

Real estate is one of the oldest and most lucrative income-producing assets. Though it can have a high barrier to entry and requires due diligence, buying an investment property can offer regular rental income, appreciation, tax benefits, and unique forms of leverage (via a mortgage).

Rental Properties

There are two types of rental properties: residential and commercial. The first involves leasing single- or multi-family properties to individuals and families. The second involves leasing office, retail, industrial, and other types of buildings to businesses.

Rental property can be a solid investment because it offers two forms of return: regular rental income and value appreciation. For example, a $500,000 single-family rental could generate $2,000 in monthly rent while appreciating by 10% per year.

In addition, property owners have more control over their investments and can take advantage of many potential tax breaks and deductions, such as depreciation and 1031 exchanges.

Keep in mind, owning rental property requires a lot of know-how. Among other things, you must maintain the property and manage tenants (unless you hire it out to a property manager).

Short-Term Vacation Properties

Short-term rentals (STRs) are a form of rental property that became popular with the rise of platforms like Airbnb and VRBO. The main difference is that you lease your property to tenants for days instead of years at a time.

This presents unique opportunities and challenges. On the one hand, the potential rental income is higher, especially in popular tourist destinations with high occupancy rates. You can also use your STR for personal use when it’s not rented out to guests.

On the flip side, STR income can be inconsistent. You may earn a lot during peak vacation season and less during the off-season. In addition, STRs require more frequent maintenance than long-term rentals since they must be cleaned before each new guest arrives.

REITs

If you prefer a passive approach to real estate, consider real estate investment trusts (REITs). These are companies that own and manage large portfolios of income-generating properties on investors’ behalf. They function much like mutual funds and can be publicly traded like stocks.

This means that, unlike rental properties and STRs, REITs are highly liquid. They also provide regular income in the form of dividends.

On the downside, investors have little control over which properties a REIT holds and how they are managed. This is left to professional fund managers, who charge management fees.

The Bottom Line

Congrats! You just learned about many different income-producing assets that can help set you up for financial success. Though not an exhaustive list, any of the investment opportunities above can be a great start to securing a stable future.

To maximize your investing potential, download the Rocket Money℠ app and start tracking your investments in one place.