People investing for income have a number of options when considering how best to make their money work harder for them. And with bank interest rates at historically low levels, those relying on interest from savings to supplement their income are increasingly recognising the need to seek out the alternatives to make up the shortfall.
Despite current stock market volatility, equities (shares) still represent the pick of the bunch when looking for long-term income-generating potential.
Investing in asset classes like property, bonds and cash all help in the drive to generate income, but history shows that equities outperform all comers over the longer term.
This is due to a number of factors: the trend for dividends from company shares to increase over time, the potential for capital gains in the value of those shares and the significant boost to those gains that can be achieved by reinvesting dividends until the income tap needs to be turned on.
This combination of rising income and capital growth over the medium to longterm is vital to help fight off the main threat to income – inflation.
Nothing guaranteed
But while in the main share values have increased over time, nothing can ever be guaranteed. So it is always essential to invest carefully and the temptation to put all the eggs in one basket should be avoided by holding a spread of investments geared towards generating income.
And with people living longer, creating sufficient income for retirement to ensure you don’t “outlive your money” has become a greater requirement than ever before.
It is true that investing in the types of assets that offer the opportunity for rising income and capital growth can be more risky than leaving money on deposit.
Deposits offer investors security and instant access to their capital when required and are therefore an important part of an overall income strategy, but inflation will reduce the real value of the capital over the medium to long term.
For example, £10,000 invested in a deposit account in 1992 would be worth around £6,600 in 2007, in real terms, if the interest had been taken as income – inflation would have reduced the spending power of the capital by almost a third (source: Lipper Hindsight).
The lack of potential for capital growth is the biggest drawback in putting too much faith in deposit accounts to meet longer-term income needs.
By comparison, the income generated by an equity investment made in 1992 would be more than double that from deposits in 2007, proof positive that equities have the potential for a rising income over the medium to long term (source: Lipper Hindsight). Of course, the value of an investment in equities can fall as well as rise, and the income produced from them cannot be guaranteed.
So what are the options when investing for income, other than equities? One is commercial property, which offers a real opportunity to achieve capital growth and a rising income to combat the effects of inflation.
Investment in a commercial property fund provides a spread across a portfolio of offices, retail outlets, warehouses and industrial premises. Upward rent reviews are a common feature of commercial property leases, providing the potential for growing income levels above deposit returns.
Although recent times have shown us that the value of commercial property can fall, overall, commercial property investment has a track record for often providing returns when other investment types may not be doing so, which can make it an important part of a diversified income strategy.
Creditworthiness
Another option is “fixed interest” investments, also known as bonds or gilts, which are loans made by investors to companies or governments. The level of interest the investor receives depends on the creditworthiness of the borrowing company or government. The more risky the borrower is, the higher the interest paid out to investors, to reflect the amount of risk the investors are making with their capital.
Investment managers tend to run portfolios of bonds spread across a range of different borrowers, with a mix of high and low credit ratings to create a well-diversified investment with a balance of income and capital security.
While fixed interest investments are often considered less volatile than equities, it is worth remembering that their value can go down from time to time and that inflation will still affect them, particularly the buying power of capital returned when the loan finishes. By carefully combining the options available, people can create investments that maximise income potential, while at the same time controlling risk to capital and providing the opportunity for inflation-beating returns.
But choosing the right blend of income-generating investments is not easy, which is why many people leave this to professional wealth management specialists in order to find the right income solutions.
This provides unrivalled access to investment know-how and the opportunity to invest across a range of different investment firms, with the peace of mind of knowing that money is being well looked after.
- For further information or to discuss any aspect of financial planning, contact the author, a founder member of The Ellis McComb Partnership, 3 Mortimer Street, Birkenhead, Wirral CH41 5EU; telephone 0151 650 6520, e-mail ellis.mccomb@sjpp.co.uk, website www.sjpp.co.uk/ellismccomb.
