Join the rentier class

by Philip Brewer on 6 January 2008 14 comments
Photo: Philip Brewer

You don't hear much about the rentier class any more. Perhaps that's because we all expect to be members by retirement age. Perhaps it's because even the very wealthy now all seem to work at something, if only at being a celebrity for our entertainment. Whatever the reason, I recommend that you take advantage of its modern social acceptability, and join the rentier class sooner, rather than later.

The rentier class, if you're not familiar with the term, are the people who live off capital: stockholders, bondholders, landowners. If you receive any income in the form of interest or dividends, then you're already on your way.

Invest for income! A money fund or an internet savings account is a good place to start, but once you have enough cash set aside in your emergency fund and you're fully funding your 401(k), start investing in bonds and in dividend-paying stocks.

Investing for income hasn't been popular these last few decades; investing for growth was the way to go. There are a couple of reasons for that. Tax policy long discouraged investing for income--you have to pay taxes on income every year, but you don't have to pay taxes on growth until you sell (and then at a lower rate). The tax rules were really just an excuse, though. The real reason that investing for income was unpopular was that it's not a way to get rich quick. That made investing for growth much sexier.

Tax policy has changed, at least for the moment. Since 2003 you've been able to get low rates for dividends. But, since tax policy was really only an excuse to prefer sexy, sexy growth over dividends, there hasn't been a huge shift in how people invest. Personally, I've always trusted income over growth. Growth seemed somehow imaginary. Income showed up in my checking account.

The reason income has alway seemed so dull is that it doesn't offer the short-cut that growth seems to (and actually does, but only to a tiny fraction of investors). If your goal is enough income that you don't need to work any more, it takes years and years of living frugally, saving, and investing for income before you reach your goal. But that's the wrong way to look at it. Long before you have enough income that you don't need to work, you have enough income to make your life better.

I think a lot of people look at investing for income, and quickly decide that the income is simply too small to matter. Buy a $1000 treasury bond at current rates and your interest payments will amount to something like $20 every six months. What's the point in that? The average stock in the S&P 500 pays a dividend rate that's even lower--you'd have to invest a couple thousand dollars just to get $10 a quarter.

The thing is, though, those $10 and $20 quarterly and semi-annual payments add up quickly. More important, they don't depend on you actually doing anything to get the money.

Just a few years of investing is enough to build up a tidy little portfolio of bonds and dividend-paying stocks. Plenty of stocks pay higher dividends than the average of the S&P 500. Pick a few that seem to be well-managed and profitable; invest in those. Interest rates on treasury paper are down near multi-year lows, but several times in the last two years it has been possible to get 5% on treasury bonds. (For how to buy treasury paper, see Treasury bills for ordinary folks.)

It may take your entire career to save and invest enough money that your investment income can entirely replace the earnings from your career. (In fact, if you don't save and invest pretty diligently, it may take more than your entire career.) But income that isn't enough to live on is still worth having. At different times in your life it can provide additional money to invest, a boost to your standard of living, or a supplement to your emergency fund if your regular income is lost.

Invest for income. Join the rentier class.

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Guest's picture

Your entry has given me food for thought. I have not really explored the idea of investing in dividend stocks or treasury bonds. Most of my investing is for retirement and dividends are automatically reinvested. However, I would not mind a few extra dollars every six months or so. Thanks for giving my financial thoughts new directions.

Guest's picture

"Most of my investing is for retirement and dividends are automatically reinvested. However, I would not mind a few extra dollars every six months or so."

If you don't need those extra dollars from dividends, it might be a good idea to reinvest them. It has a compounding effect which makes you have more dividends at the next payout. Without putting in any new money, as long as the dividend payout of whatever you're investing in does not go lower, you're getting a higher yield on your original money.

Guest's picture
Dwight

Would a person's tax return be too complex if he owned a lot of treasury notes that are small in size?

Is it be better to save until you can afford $10,000 notes? Or, is it be better to buy a $1000 note every time you have some extra cash?

Guest's picture
db

Can anybody recommend a good getting started book for income investing?

Philip Brewer's picture

The taxes are no harder with a dozen treasury notes than with one. You get one combined statement with the total of all your interest payments, which is all you need to do the taxes.

The only advantage to getting a few, larger notes instead of many smaller ones is if you're keeping track of everything manually, and have to enter all the small interest transactions by hand.

I'd be inclined to go with buying a note everytime you have some extra cash. For one thing, you're less likely to get hung up on whether you're getting the best rate. (Worrying about that sort of thing can drive you crazy.) Also, if you have just a few notes, your income can change a lot each time one of them matures and you reinvest the money (getting whatever the interest rate is then). With many smaller notes, the effect of falling interest rates would only hit your income gradually, giving you time to adjust.

Guest's picture

Excellent post - you're exactly right. Investing in high-yielding stocks is an excellent way to generate a (passive) income stream without investing too much time and effort in to the selection process.

Guest's picture
Minimum Wage

Where's Pat Sajak when you need him?" I'd like to buy a vowel.

Philip Brewer's picture

Clearly the compounding effect of reinvesting is a huge part of eventually becoming wealthy.

But I was trying to make the point that investment income has uses besides just compounding for eventual future wealth. Even a pretty small amount of extra income can be an important cushion during a financial emergency, or a boost toward covering an expense that would otherwise have been a burden.

If you invest a few thousand dollars so that it provides an extra $10 or $20 a month in income, and then spend it--well, you're not going to make much progress. But if you start by reinvesting, then long before the income reaches levels that would allow you to retire, it can still have uses that can make a big difference in your life.

Philip Brewer's picture

@db:

I was hoping that someone else would have a recommendation, because I don't, really. Investing books these past 20 years or so have been overwhelmingly aimed at people saving for retirement. If they talk about income at all, it has been purely as an alternative to growth--as something you could buy when the growth stocks were overvalued because growth had been hot.

So, if somebody has an idea, we'd like to hear it.

(If there's really the gap there seems to be, maybe there's a market for a new book on income investing....)

rstlne's picture
rstlne

You can do much better than Treasury notes by investing in income trusts and MLPs. However, those require some research. Also, some municipal bonds yield almost as much as Treasuries now, which is good because of the tax advantage.

Guest's picture
Kelja

Investing in treasuries is OK if you plan to hold on to that treasury bill until the end. Treasuries & Bonds can fluctuate in price quite a bit, something a lot of novices aren't aware of. For instance, if future treasuries pay a higher interest than the one you bought (something I think will happen), then your treasury is worth that much less. That is not a concern if you will hold the treasury until term - 5,10,30 years, whatever. You still receive the promised interest on it. But, if you had to sell the bond earlier to raise capital, you lose money.

Something to keep in mind, is the erosion of your money via inflation. It's not a secret the government skews the inflation figures for their benefit. The official inflation number should be much higher. Just take a trip to the grocery store or gas station to find that out. Bottom line, whatever interest you make on your money HAS to exceed the inflation number, otherwise you're going backwards.

One more thing - you buy US bonds or treasuries, you buy them in US dollars. If you haven't noticed, the dollar has fallen more than 30% in the last 5 years and probably will fall much more. And that doesn't just affect you if you make trips abroad, but because most of our manufactured items and a lot of our raw material (oil) is purchased from foreign sources, your costs go up by how much the dollar drops.

There's no easy way to ensure you have anything left when you retire. In the old days, before government interference, people either saved (inflation wasn't much of a worry), built business or bought rental property that would provide cash flow, or relied on family to take care of them.

It's truly a new 'paradigm'. The average Joe/Jane has to develop a financial acumen that they have neither the time, motivation, or education to do.

Philip Brewer's picture

It's true that "Join the rentier class" is not a complete investment strategy all by itself--but dig into Wise Bread's archives, and you can get most of the pieces of one.

I'm sharply attuned to the risks of inflation. (The modern inflationary peak in 1980-1981 came just at the point when I was setting up housekeeping for the first time in my life. I remember vividly what an inflation rate over 12% does to a household budget.) But the fact that there is inflation doesn't make investing for income invalid, it just means that you can't take the returns at face value--you have to do a little mental arithmetic first.

There are a lot of other income investments besides the two categories I mention (treasuries and dividend-paying stocks), but they're the only ones I feel comfortable recommending without a lot more information about how to research them. The others have their place, but any that pay a higher return are naturally going to carry higher risk.

As long as you have your emergency fund (for emergencies) and your maxed-out 401(k) (for retirement), you're in a position to take some risks. If you're comfortable with that risk, go for it. But, if you're not, then my whole point is that people can join the rentier class in a small way without needing to take the high risks that might (if the reward matches the risk) let them join the rentier class in a big way sooner.

Guest's picture
Matt

A couple good books that really opened my eyes to this possibility are by Derek Foster - Stop Workng and the Lazy Investor. He is Canadian and some of the advice is specific towards Canadians but the overall message applies to anyone. He retired at 34 by seeking purely income-generating investments and does a good job of dispelling the myth that you need X amount of dollars to retire.

If you can't find the books at the bookstore, you can order them from his website - www.stopworking.ca

I have no personal interest in his books other than finding them very informative.

Guest's picture
Hannes

I will really look into this. I have yet to start investing, as I am putting all my spare money into paying off debt atm, but once that is done, this will deffinately high on my list of options.