Ordinary income

Money an investment pays you while you still own it - interest, dividends, rent, coupons - typically taxed in the year it is received.

Example

A deposit paying 5.00% produces ordinary income every year even if nothing is ever sold.

Important

Because it is taxed as it arrives, income-producing assets give up the compounding that deferred gains keep - which is why the same headline return can leave you with different amounts.

Related terms

• Capital gain — The profit made by selling an asset for more than it cost, as distinct from the income the asset paid you while you held it.
• Withholding tax — Tax deducted at source from a payment before it reaches the investor, most often on dividends or interest paid across a border.
• After-tax return — The return that remains once the tax on it has been paid. The only version of a return an investor can actually spend.

Lessons that explain it

• Four risks, an invisible dealing cost, and why interest is often the worst-taxed return — Credit, rates, inflation and liquidity are four separate risks that a single word - safe - is routinely used to dismiss. The tax treatment of interest is the one most holders never price at all. (12 min)
• The nominal safety that loses money anyway — The balance cannot fall, and that is exactly why the real risk in this class is invisible. Inflation reduces what the money buys, and the tax is levied on the nominal interest rather than on what you actually gained. (13 min)
• Total loss is an outcome here, not a tail — Four separate routes lead to zero, none of them exotic. Then the volatility arithmetic, the costs nobody totals, and a tax treatment that can leave a bill in currency against a position that has already fallen. (13 min)
• Defaults cluster, exits close, and interest is often taxed as income — The key risks are defaults rising together in a downturn, being unable to exit, and intermediary failure. Costs include layered fees, and interest is frequently taxed less favourably than gains. (12 min)
• Leverage runs both ways, the round trip costs six per cent, and selling takes months — A mortgage multiplies the price move by four in either direction. The transaction costs are fifty times a broad fund's. And the exit is measured in months, at a price you negotiate rather than accept. (13 min)
• Pre-tax or post-tax is really a bet on your tax rate now versus later — The two main account structures give the same result if your tax rate is the same when you contribute and when you withdraw. The choice turns on whether you expect your rate to be higher or lower in retirement. (12 min)

All 578 terms in the Investing glossary