What Is Investment Income?

If you ask investors why they invest, you’ll probably get several different answers.

For instance, they may want to buy a house, build wealth, save for retirement, etc. No matter the personal goal, the bottom line is this: When you invest, you’re hoping to make some money! 

The money that you make from your investments is what's known as investment income. Pretty straightforward, right? But different types of investments can generate different kinds of income. 

Some of you may be thinking: “Hey, money is money – what’s the big deal?” Fair question. 

First, it’s important to have a basic understanding of how investment income works because it can help you choose an investment strategy that best fits your needs and goals.

Second, you usually have to pay taxes on investment income, and the tax rate will depend on the type of investment income you bring home. We won’t get too much into the tax discussion in this article since we’ve covered the topic here. 

Ahead, we’ll focus on helping you nail down the basics by providing an overview of three common types of investment income: interest, dividends and capital gains.

Interest income

Even if you’re brand new to investing, we bet you’re already familiar with interest income, which is the money you can earn through certain types of bank accounts and investments. Let’s look at a few examples. 

When you park money in a savings account, money market account or certificate of deposit (or “CD”), the bank doesn’t just hold onto your deposits for you – it can lend that money to others.

Since you’re essentially letting the bank borrow your money, the bank pays you interest for it in return. Now, even though these deposit accounts aren’t typically considered investment products, the IRS treats the interest earned from these accounts as investment income for tax purposes.  

Dividends 

When you buy stocks, you have an ownership stake in the company (or companies) you invest in. If the company makes a profit, they may distribute some of that money to their shareholders (that’s you!) in the form of dividends. 

Here’s a basic example of how dividends work. You invest in Company XYZ and own 100 shares of its stocks. The company pays $5 per share in annual cash dividends. That means that you would earn $500 ($5 x 100 shares) in dividend income. Sometimes, you may have the option to reinvest cash dividends back into the company, allowing you to buy more shares. 

Some companies may choose to pay dividends in the form of additional shares instead of cash – this is known as a stock dividend. 

Now, you don’t have to invest directly in a company to receive dividends. If you invest in stocks through a stock mutual fund or stock ETF, these investments can also pay dividends. 

Good to know: While dividends can be a nice source of income, they’re not guaranteed. The decision to distribute dividends is usually up to a company’s board of directors. The board can decide, for example, when and how much dividends will be paid to its stockholders.