Whether you’re looking for regular money in retirement or building your investments, an income strategy could be the solution. Freelance writer Rosie Murray-West explains.
We live in uncertain times – with continued volatility* in global stock markets, fluctuating oil prices and concern about slowing economic growth. And then there are interest rates, which in the UK show little sign of picking up soon. In this environment, the typical return from a cash savings account is small. So many people are looking for a place to put their money that provides regular income.
The need for income is greater than ever – thanks to new pension freedoms that allow us to use our retirement savings more flexibly. Added to this, many of us can expect to live longer in retirement. But it isn’t only those nearing the end of their working lives who need to think about income investing. It’s essential for many stages in life.
So what exactly is income? It could be:
• Interest from cash savings
• Dividends from shares
• Payments from bonds, also known as fixed income
• Rental returns from property
*Volatility: the extent to which the value of an index or financial instrument moves up and down. Higher levels of volatility tend to be unwelcome as they lead to uncertainty over the future value of investments.
The snowball effect
If you don’t need the income from your investments immediately, you can reinvest it. Research shows that rolling your income back into your investments has a huge impact on its eventual size. It’s a snowball effect – otherwise known as compounding. Put simply, by rolling your income back in, you get income on your income.
To illustrate this, figures from the Barclays Equity Gilt Study (2015), an annual report that looks at the historic performance of different investments, show that if you had invested £100 in the stock market in 1945, it would now be worth just £261 in real terms if the dividends had been spent. Not so good.
However, if the dividends paid on the shares had been reinvested, the result would be £5,118 in real terms.
One solution: the fund
Clearly, income is vital to those who want to grow their investments – and to anyone who needs regular cash in retirement. So where can it be found?
Investors have a variety of choices to generate income, all of which involve different levels of risk and return. As a general rule, the lower the risk, the lower the return – and vice versa. For most people, it’s sensible to take a diversified approach to income investing. That means developing a mix of risk levels and income-producing investments – known collectively as assets. One way of providing this diversification is to invest in funds. Funds spread your cash more widely by pooling it with that of other investors and making a spread of investments. This helps ensure the fund isn’t overly invested in one region, industry sector or type of asset.
Here are some of the options income-hungry investors might consider.
Shares – also known as equities
Companies do not have to pay an income to shareholders, but many do. They often choose to return some of their profit through dividends, usually once or twice a year. Occasionally they will pay a ‘special dividend’ if something specific has happened that has left the management with extra cash – for example, the sale of part of the business. But a share dividend can’t always be relied on. Companies can choose whether or not to pay out, depending on their financial health. Income investors should check a company’s dividend history. If the business has paid out regularly for many years, it is more likely – but not certain – to continue to do so. You can also check a measurement called the ‘dividend cover’ – the amount of profit the company makes compared with the dividend. This is one measure which can help to indicate whether the dividends the company is paying are sustainable. And remember, the value of the shares you are invested in moves up and down, too.
Bonds – or fixed income investments – are forms of debt issued either by governments or companies. They pay investors income in the form of a ‘coupon’ – a fixed regular payment. They pledge to pay back the debt at the end of a fixed period.
Unless you buy corporate and government bonds from the issuer on the day of issue, the price paid for them varies. Bonds are seen as less volatile than equities, because the regular payment is guaranteed by the issuer – provided the issuer doesn’t go bankrupt. However, they are not entirely without risk. Equally, government bonds are typically seen as less risky than corporate bonds. After all, most countries are unlikely to default.
Many of us think that you can only get income from property by buying houses or flats and renting them out. Not true. There are funds and other products that directly invest in the property market. These include real-estate investment trusts (REITS) and specialist property funds that invest in commercial bricks and mortar. They do this in a similar way to a fund that holds shares in a company – pooling investors’ money and investing in a spread of properties, such as offices, warehouses and leisure facilities. Some of these funds will pay a regular income. Their value will move up and down depending on the strength of the commercial property market.
Funds that invest in a variety of assets within one wrapper are becoming increasingly popular. These funds employ expert managers who attempt to create a mix of assets for diversification purposes.
Multi-asset funds that concentrate on creating an income contain a mix of assets with the aim of providing steady income and growth. Such assets can include:
• Corporate bonds
• Government bonds
• Commercial property
Creating the right income-producing strategy for you will involve a mixture of assets, well diversified across geographies and sectors.
Help is at hand
If this sounds daunting, help is available – particularly if you invest through funds. DIY investment platforms provide fund factsheets with statistics about past performance as well as their current make-up. An independent financial adviser can help you further by looking at your goals and constructing a plan – all for a fee. Try the Personal Finance Society www.thepfs.org/yourmoney
to find advisers.
Rosie Murray-West was, until recently, deputy editor of the Telegraph Money section and before that the newspaper’s Questor Editor. She now writes regularly for a variety of publications including the Telegraph, Times, Sunday Times, Mail on Sunday, Observer and Moneywise magazine, covering all aspects of personal finance, as well as business, property and economics. She was named Financial Freelance Journalist of the Year (runner up) in 2015 by Santander, and won the Santander Award for Personal Finance Education in 2011.