DEMAND for savings and investments that produce a regular income has rarely been greater. With cash savings falling short of inflation, gilt and some corporate bond yields thinning and declining annuity rates creating problems for those nearing or in retirement, regular income has become the holy grail of investing. Ross Middleton, an investment manager with Murray Asset Management, gives his top ten tips on investing for income.
1 Don’t ignore capital
One of the most significant contributors to long-term returns from the stock market is the reinvestment of dividends. Withdrawing income from investments reduces the potential for future long-term growth, so any income-producing strategy has to set a balance between capital and income growth.
2 Avoid the valuation trap
The “chase for yield” can lead to investors paying premium valuations for higher-yielding stocks. Fixed-interest securities have been a traditionally core and popular area for those requiring an income, but some experts are now concerned by the prices of many of these assets, amid fears that they are too high. As with any investment, it important to undertake adequate research and ensure you are not paying more than is necessary for income producing assets.
3 Inflation
Mitigating the effects of the rising cost of living is one of the big attractions of equity-based income investing. Income derived from the stock market offers some degree of inflation protection as many companies have the ability to pass inflationary pressures on through increased prices.
4 Which tax to pay?
The difference between income tax and capital gains tax (CGT) rates needs to be considered by those whose emphasis is on income. CGT is paid at a flat rate 28 per cent, while dividends attract a rate of 42.5 per cent for those taxed at the highest rate. However, every individual taxpayer has a CGT allowance, currently £10,600, which can be employed to avoid or reduce any potential tax liability. As a result, it may be more beneficial to sell all or part of an investment to supplement income, rather than collecting cash through dividends.
5 Wider tax planning
Several useful tax planning strategies can be adopted in relation to income-producing investments. These include transferring investments to a spouse who pays a lower rate of tax, or investing in individual savings accounts (Isas) to ensure any potential tax paid on income is avoided or reduced.
6 Diversification
It’s vital to ensure a sensible spread of investments to reduce the level of risk taken and avoid relying too much on any particular area. Think of the fate that befell investors with significant exposure to UK banking shares, who in the wake of the financial crisis would have experienced a considerable reduction in income as well as significant capital losses.
7 Overseas opportunities
Investing overseas has traditionally been associated with the aim of achieving capital growth, but a growing number of fund management groups now offer funds providing access to overseas markets that provide the potential for income as well as growth. Examples include the UBS Emerging Markets Equity Income Fund, which yields approximately 5 per cent, and the Aberdeen Asian Income Fund. The latter is an investment trust listed on the London Stock Exchange, which offers investors an income yield of around 3.5 per cent, as well as capital growth through investing in Asian companies.
8 Sums and terms
Clearly, the level of income received will depend on how much capital is invested, not just in real terms but also in relative terms. For example, for anyone seeking income through lower-risk investments, National Savings income bonds pay higher interest rates for amounts over £25,000. Based on current interest rates, someone investing £500,000 in National Savings income bonds would earn £8,750 a year before tax, equivalent to a gross interest rate of 1.75 per cent.
9 Ancillary expenses
Investing in mixed portfolios invariably means incurring ancillary costs, such as dealing commission and annual management charges. If the sum you have to invest for income is relatively small, weigh up these expenses carefully as an alternative savings/investment option may be more appropriate.
10 Complementary ‘annuity’
Most retirees who have built up a private pension draw their principal monthly income from an annuity (a guaranteed income from the pension “pot” they built up during their working lives).
Unfortunately – for economic and political reasons – the value of annuities has dropped substantially in recent years, with a negative effect on pension incomes.
Consequently, anyone with cash reserves (perhaps earning little or no net interest in a bank account) could consider investing in mixed portfolios with the intention of securing a regular supplement to the income they receive from their annuity.