Tania Smyth, Morgans
With interest rates remaining at historical lows and below inflation, it will come as no surprise that the story from conservative new investors seeking advice is consistent: “My bank recently sent the notice for my maturing term deposit, and I can’t live on 0.5% each year,” they say. “What can I do?”
At the forefront of any investment decision, you should ask yourself, “how do I feel about and perceive risk?” The conservative investor above has concluded there is a risk remaining invested in term deposits. The risk is that they are not earning enough to sustain their cost of living. But how much risk can you tolerate?
As an adviser, I spend a lot of time talking to clients about risk, what risk means to them, are they solely relying on their investments for income and how long does the money need to last? These conversations are extensive and can be revealing.
ASX provides access to a range of investment options in different asset classes, such as shares, hybrids, bonds and funds, with a focus in recent years on investments that generate an income return.
It’s an area of investment that is full of complexity, nuances and risks. Seeking advice can assist you to invest in the best mix to meet your risk and return needs.
Some of the types of investments I may consider as part of the mix for investors may include but are not limited to:
In the current interest rate environment, investing for income is a particularly difficult task for any investor, and indeed for an adviser too.
The Reserve Bank of Australia continues to set the cash rate at a record low of 0.1%. This is the benchmark rate in which all interest rate products are based, including the traditional bank deposit accounts and term deposits. With interest rates at such a low level, investors continue to face an incredibly challenging environment in which to earn income.
A few years ago, you may have been able to get a 2% return from investing in a bank term deposit for 12 months. Today it’s rare to get 0.5% from the same institution and with the same maturity. That is a very low return for investing your money coupled with the fact that you are locking that money away for a whole year. To many, that scenario doesn’t make sense, despite there being very little risk in not getting your money back at maturity.
Andrew Eddy, Morgans
It is possible to earn higher rates of return, however, the trade-off between risk and return is just as relevant right now for someone looking for income, as it is for someone who is looking for growth from the sharemarket. Now more than ever, investors need to be acutely aware of all the risks when investing into other investment products that offer higher rates of return.
These days we are spoilt for choice when it comes to investing into products that have an income focus. The ASX has all sorts of listed securities that can be bought for income generation. Capital notes, convertible preference shares or hybrid securities are great options for some, as they can pay attractive distributions with franking credits. But you do need to be careful with how they are used and how much exposure one should have in their portfolio.
There are also several listed investment companies and trusts that have a focus on generating income for shareholders. These often provide advantages in terms of diversification as well as a professional investment manager who helps to invest your capital carefully.
However, there is no free lunch when it comes to finding higher rates of return and you need to ask yourself why is this investment opportunity able to offer such a good rate compared to current cash rates? The answer will almost always be because of the potential risk to your capital.
Many investors will have asked, or be about to ask the question, “why stay in fixed interest with such meagre returns?” Many will be seduced by the sharemarket with the potential to receive very attractive fully franked dividends from the banks, infrastructure stocks or even more recently the resource sector. This can be a valid alternative for some who have the risk tolerance and the longer-term investment timeframe. Furthermore, you can also boost your returns with capital growth potential over time.
One trap that many may fall into, however, is buying into a share with a short-term view of collecting a nice juicy dividend and then looking to trade out of the share and moving on to the next opportunity. This strategy is fraught with danger, as often share prices don’t increase or they stay where they are. A good example of this has been the recent volatility in the iron ore producers like BHP (ASX: BHP) and Rio Tinto (ASX: RIO).
As an adviser, I am often asked to come up with a portfolio that can produce a 5% income return. It can be done even today, but you need to have your eyes wide open from a risk perspective.
One final, important tip: seek professional advice that can give you this confidence and perspective to find and commit to the ideal income strategy for you.