What is Investment Income?
Investment Income is the income that is generated through dividends, payment of interest, and capital gains through the sale of any asset or security and profits made by any kind of investment vehicles like bonds, mutual funds, etc. Generally, people earn a large quantity of their total income every year from their salary income but, properly planned savings and the investments in the financial markets can actually convert nominal savings into big portfolios of investment, which will surely yield that investor a good investment income over the time.
Top 3 Types of Investment Income
There are several types of investment incomes out of which major ones are explained below:
#1 – Interest
A person will earn income as an interest in investments that generate interest in the deposition of funds into bonds, certificates of depositsCertificates Of DepositsCertificate of deposit (CD) is a money market instrument issued by a bank to raise funds from the secondary money market. It is issued for a specific period for a fixed amount of money with a fixed rate of interest. It is an arrangement between the depositor of money and the bank., money market instrumentsMoney Market InstrumentsThe money market is a market where institutions and traders trade short-term and open-ended funds. It enables borrowers to readily meet finance requirements through any financial asset that can be readily converted into money, providing an organization with a high level of liquidity and transferability., etc. earlier, the investors who are in need of some cash can withdraw money from their interest income without even disturbing the principal amount invested. But nowadays, the interest rates are very low hence;, it’s really difficult to expect the same return from dividend and interest on a consistent basis.
If a person utilizes the interest income either from cash, taxable bonds, or certificate of deposits, the same is taxed at the regular income tax rate. Additionally, if the investment is long-term, then that person is required to show the interest income earned in the income tax return even if you do not withdraw cash from that investment.
#2 – Dividends
DividendsDividendsDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company. are paid by the companies on the basis of their earnings to the shareholders or investors on a per-share basis of the stock. If the investment is in mutual fundsMutual FundsA mutual fund is an investment fund that investors professionally manage by pooling money from multiple investors to initiate investment in securities individually held to provide greater diversification, long term gains and lower level of risks. that have funds into dividend stocks, then the investor earns a share of that company through dividends on a yearly or quarterly basis.
The taxes are to be paid on dividends as well, and the regular tax rate applies to these Ordinary dividends, whereas there are some dividends labeled as “qualified” are taxed at a capital gains rate that is generally lower.
#3 – Capital Gains
A rise in the asset’s value, like in an investment on real estate or stock, which is more than its purchase price then, that increased value is the capital gain, but the same is realized only when the underlying assetUnderlying AssetUnderlying assets are the actual financial assets on which the financial derivatives rely. Thus, any change in the value of a derivative reflects the price fluctuation of its underlying asset. Such assets comprise stocks, commodities, market indices, bonds, currencies and interest rates. is sold. The investor has to pay taxes on the capital gains according to the period of the gain, whether it is short term or long term capital gain. The long term holing of any investment is better than the short term as the tax rates are lower on long term capital gains.
Investment Income Examples
The following are the different examples of investment income:
#1 – Dividend
If an investor holds 100 shares in a corporate and that entity pays 50% of its earnings as dividends and says the earnings are Rs. 10 per share, therefore, the dividend amount is Rs. 5 per share, the investor, earns Rs. 500 per year i.e., 100 shares multiplied by Dividend Per ShareDividend Per ShareDividends per share are calculated by dividing the total amount of dividends paid out by the company over a year by the total number of average shares held. Rs. 5.
#2 – Capital Gain
An investor “A” invests an amount of Rs. 1000 to buy 20 shares of a company selling at par i.e., Rs. 50. Next year the price of that share rises to Rs. 70 per share and “A” decides to sell ten shares from his stock; then, his capital gain will be Rs. 200 [ 10 shares @ Rs. 70/ share = 700 less original price 10 shares @ Rs. 50/ share = Rs. 500 ].
The various advantages related to the investment income are as follows:
- It helps in Building up Wealth – An investor will earn income over regular intervals, which he can further invest or reinvest in other or the same stock, property, or land.
- Investment Income has Retirement Benefits – If a person has invested in any mutual funds, stocks, FDs, etc. they earn interest and dividend over it, which a person can use or further invest. By further, they earn an interest rate on a compounding basisCompounding BasisCompounding is a method of investing in which the income generated by an investment is reinvested, and the new principal amount is increased by the amount of income reinvested. Depending on the time period of deposit, interest is added to the principal amount., which will help them to have a great life post-retirement.
- It helps in Achieving other Financial Goals – Last but not the least, the investment income can be utilized in completing other financial goals like saving this income for your child’s education, or nowadays there are EMI services for everything; therefore, the person can pay its installments through these extra incomes instead of their salary.
The various disadvantages related to the investment income are as follows:
- Market Risk – The market is very fluctuating, and so the investor has no idea how much he will earn this year. Sometimes he can earn a good amount of income, and at times there can be a very low generation of income. It all depends on the market, and the investments are chosen by the investor, so he needs to think and then invest.
- Choice of Investment – An investor has to choose amongst the variety of investments to make sure that he earns a nice amount of income. If he chooses some investment that has fixed income generation, then he will never get a high return if the market is high and vice versa, so the choice of investment is very important.
- Application of Tax Rates – There are different tax rates on investment incomes. There are only a few investment incomes that are exempted from taxExempted From TaxTax-exempt refers to excluding an individual's or corporation's income, property or transaction from the tax liability imposed by the federal, local or state government. These exemptions either allow total relief from the taxes or provide reduced rates or charge tax on some items only.; otherwise, all incomes attract tax. Some attract tax when they cross the amount limit of the income, and some differences in rates like in the short term and long term capital gain.
The various important points are as follows:
- There are several types of investment incomes out of which major ones include interest incomeInterest IncomeInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. , capital gain, and dividend income, etc.
- Investment incomes help in saving taxes as there are much tax-free or tax saving investment schemes that attract investors to invest as they save a lot of tax for people.
- The investor will be able to face inflation. If a person has invested his funds in fixed income generation investment, then his income is fixed from his investments, and during the inflation, when rates are so high, then also he will be earning the same income and can spend it appropriately.
This is an income that generates from interest, dividend, and capital gains. It is a good practice to keep investing in stocks, bonds or mutual funds, etc. people have at least a generation of income from these investments, which helps them in keeping up with their monetary needs or wants. Some investments help in tax saving also, which is an advantage to the common man. The chosen investments should be a wise choice that generates a wealthy return.
This has been a guide to What is Investment Income, and it’s Definition. Here we discuss the examples of investment income and types along with advantages and disadvantages. You can learn more about investments from the following articles –