Income investors have been feeling the pinch for years. With interest rates at near-historic lows, many have been forced to take more risk with their money to obtain decent income yields.
This demand for yield has had the secondary effect of driving up prices of assets that pay a reliable income, forcing investors to pay premium prices. This situation is now seemingly easing.
‘It has been a tough climate for income investors in recent years. But there may be some light on the horizon, with interest rates starting to edge up both in the UK and the US,’ says Simon Crinage of investment bank JP Morgan.
Markets may remain testing but there are steps investors can take to maximise their income potential while ensuring they’re not risking too much with their capital. Following this seven-point plan is a good place to start.
1 Take a multi-asset approach for income
It’s important to diversify your investments across asset classes. This diversification allows investors to buy into higher-paying assets, but ensures not all their capital is tied up in riskier investments.
Beyond bonds and equities, investors may want to consider assets such as property, cash or infrastructure. A multi-asset investment trust with an income focus could be a good way to gain such diversification.
‘Multi-asset funds can do the job on your behalf, with a professional fund manager deciding the split of your investments and ensuring the fund isn’t overweight in one particular area,’ say investment experts at Barclays.
2 Look at overseas investment trusts for dividends
The UK has historically been a good place to invest in equities with decent dividends. But recently, there has been an increase in the number of global trusts and funds with an income focus.
‘More overseas companies are now focused on using profits to make dividend payments to investors,’ says Stephen Macklow-Smith, a portfolio manager at JPMorgan European Investment Trust Income (JETI). ‘This has created more options for income investors.’
By investing in a mix of UK and global investment trusts, investors can help to further diversify their holdings.
Shares explained last year how Henderson International Income Trust (HINT) does exactly this, finding opportunities in overseas markets, which you can read for free here.
3 Think flexibly to protect investment capital
If you take a regular fixed income from your portfolio, this can magnify capital losses when markets fall.
In a prolonged downturn, investors should be prepared to reduce the income taken to help preserve their capital, believes JP Morgan’s investment team.
If not, they may be forced to take a larger slice of the remaining funds to meet their income needs, further depleting their portfolio.
4 Phase pay dates in investment
Think about how regularly your investments pay an income. Is it annually, every six months or more frequently? Most dividends will be paid once or twice a year, depending on the company’s dividend policy, and corporate bonds and gilts typically pay their fixed income annually.
Looking through the payment dates of your investments can help you stagger your income payments.
5 Review your investments
It is worth reviewing your investments regularly, all investment advice agrees with this. Have these investments paid the income you expected? If they underperformed, you may want to consider rebalancing your portfolio.
‘Investing in company shares, or equities, is generally acknowledged as the best way of providing growth that beats the effects of inflation over the long term although it does involve capital risk,’ says the investment team at BlackRock.
But this can be balanced with judicious investment in lower risk assets, such as corporate bonds, gilts and property, for example.
6 Reinvest surplus income in investment
Where possible, reinvest surplus income payments to boost overall returns. The power of compounding cannot be overstated and over time, this should help grow your capital, delivering a more sustainable long-term income stream.
Shares has explained the process and power of compounding on returns many times, but this ‘Dummies’ guide to compounding’ from November 2017 provides a very simple illustration.
7 Don’t overlook capital growth in investment
If you want your retirement saving to provide a sustainable income for 30-plus years, you need to ensure your capital is growing.
‘Focusing solely on investments that pay the highest yields potentially puts this capital at risk, which could jeopardise the income you receive long-term. Try to balance income needs with growth options,’ says JP Morgan’s investment team.
