How to Turn Income Into Wealth

The ultimate goal for many investors is to be able to live off the money that their investments generate. From that perspective, true wealth isn't defined by amassing a specific dollar amount, but rather by whether or not your money earns enough for you to pursue your life's passion. It's a great target, and it's achievable. You just need the dedication to work toward your dreams, the discipline to take small steps every month, and the patience and time to invest for the long haul.

Get there from here
To borrow from Stephen Covey's The 7 Habits of Highly Effective People, we must begin with the end in mind. We need a clear understanding of exactly what we're trying to achieve. In this case, what we're really looking for can be summed up in two simple points:

• Enough current income to cover our expenses
• Enough income growth to keep up with inflation

With those goals in mind, the path becomes clear. The absolute best investments to achieve those goals are dividend-paying stocks. While most people think of bonds for income, bonds alone won't fulfill your needs. Most bonds, after all, don't raise their payouts in line with inflation. Those that do often come with nasty strings attached -- such as taxes on income that's not actually received in currently spendable form.

The right kind of stocks, on the other hand, can give you the best of both worlds. You can collect income today, plus automatically receive enough income growth to better your chances of keeping up with inflation. Unlike bonds, stock dividends aren't fixed for eternity. As a successful company matures, it can reward its owners by increasing its payout. It's these sorts of shareholder-focused companies that my friend and colleague Mathew Emmert seeks out for subscribers of Motley Fool Income Investor.

4 + 4 = Great
Of course, in the stock market, there is no such thing as a free lunch. Rapidly growing companies tend to pay very little directly to their owners, preferring instead to reinvest cash flow to grow the business. Stagnant, decrepit enterprises, on the other hand, may pay out significant chunks of cash, but they lack the growth potential to continue raising their payouts at any appreciable rate. To reach those goals outlined above, you need to find a balance. Find the right combination of a decent current payout with a sufficient prospective payout growth rate, and you can get to that sweet spot. Keep investing in such companies long enough and reinvest your dividends appropriately, and you'll find yourself with both your current and your future income needs covered.

One way to find that sweet spot is by starting with a stock screen I call "4 + 4 = Great." Essentially, it looks for companies that have a 4% or higher current payout and have raised their dividends at a 4% or faster rate, compounded over the past one-, five-, and 10-year periods. While a screen can't tell you what will happen in the future, companies with a history of paying and raising their dividends don't tend to change that pattern unless there's a significant breakdown in their businesses. As such, this screen is a good place to start. In the table below, you'll find a small sampling of the dozens of companies that passed:

Each of these companies has a track record of paying its owners well and raising those payments at or above rates that kept up with historical inflation. Those are exactly the traits you need to find if you're looking to build a portfolio that can eventually replace the income from your paychecks and give you the freedom to follow your dreams.

The Foolish bottom line
By regularly investing in firms that pay strong dividends and raise their payments in line with their business performance, you can build a solid foundation for your future. Once your money starts working hard enough to take care of you, you'll be free to pursue your passion. With its laser-like focus on finding those firms that pay their owners well, Income Investor is an excellent guide to help you launch your journey. With enough time, the right roadmap, and a dedication to invest toward your long-term goals, nearly anything is achievable. It's up to you to take that first step.

Are you ready for your money to begin earning some serious cash for you? Click here to join Income Investor free for 30 daysand start getting paid to invest.

At the time of publication, Fool contributor Chuck Saletta owned shares of Bank of America and of Kinder Morgan Management, a related company to Kinder Morgan Energy Partners. Bank of America is an Income Investor recommendation. Pfizer is an Inside Value recommendation. The Fool has adisclosure policy.