With interest rates at historic lows, investing for income has become a challenge for many people, especially those who have retired or are close to it.
Sure, it’s safe to leave your money in the bank – where deposits of up to $250,000 with each approved institution are guaranteed by the federal government – but your returns are unlikely to even keep pace with inflation.
The cold, hard fact is you need to take on more risk to earn better returns. But the dilemma for many investors is how much risk they can take and still sleep at night.
You can mitigate risk by diversifying, not putting all your eggs in the one basket.
Don’t ever be tempted to put all your money into just one investment because it’s a good income payer. An example of this is popular dividend-paying shares.
Protect yourself in your quest for higher returns by diversifying not just across shares but also across asset classes. Property, selected mortgage funds and corporate debt can also produce good income.
And if choosing individual shares is not your bag, or you don’t have enough funds to diversify, exchange traded funds (ETFs) and listed income companies (LICs) are good ways to go.
Here are four options for investors chasing income:
LICs invest in companies aiming to generate good returns for shareholders, paying out profits as fully franked dividends.
1. You can get a lot of diversification with as little as $500.
2. LICs can trade at a premium or discount to their net tangible assets (NTA), which they have to publish every month. An LIC trading at a discount can provide a good buying opportunity.
3. Because of their company structure they can retain some profits to smooth out dividends.
1. If a LIC is trading at a discount this can also be an early warning sign of problems.
2. LICs are prone to the overall volatility of the stockmarket.
3. Unlike managed funds, they don’t offer a regular savings program.
ETFs are another way to get a big bang for your buck.
While traditionally they invested in indices and were passive vehicles, more recently there has been a trend to actively managed ETFs.
There are a group of ETFs designed for investors seeking regular income, and ETFs concentrating on fixed income are also increasing.
1. ETFs offer heaps of diversification and choice for low cost as they generally invest in a diversified portfolio, which can be difficult for retail investors to access or replicate.
2. You don’t have to complete any forms or additional paperwork, as you do with traditional managed funds.
3. Active ETFs are more transparent than traditional managed funds, as they provide intra-day pricing via the stock exchange.
4. Likely to trade at or near their NTA.
1. You pay brokerage every time you buy or sell an ETF.
2. They suffer from volatility. The potential for large swings will mainly depend on the scope of the fund – one that tracks a broad index is less likely to be as volatile as one that tracks a specific industry or sector.
3. Smaller ETFs can lack liquidity because they’re thinly traded.
Corporate bonds offer predictable income, capital stability, diversification and the potential to earn better returns. You can invest through a fund or direct.
One way to go direct is to invest in XTBs (exchange traded bonds), which are traded on the ASX through many brokers and have no minimum investment. There are also many managed funds investing in both corporate and government bonds and listed vehicles, including ETFs and mFunds.
1. Corporate bonds are generally less risky than shares issued by the same company and bond holders generally rank higher than shareholders if the company fails.
2. Corporate bonds can offer a stream of coupon payments and the return of the principal on maturity. Alternatively, the payment of share dividends is at the discretion of the company.
3. You can design a relatively stable income stream from corporate bonds by investing in bonds from different companies that have different maturity dates.
4. Corporate bond prices are usually less volatile than shares for the same company.
1. Corporate bonds are unlikely to give you capital growth.
2. If you decide to sell your bond on a secondary market before maturity you may get a lower price than the face value.
3. There may also be fewer potential buyers for the bond, which can be a problem if you need your money back quickly.
These funds had a tough time in the GFC, and many never really recovered. As they have had a chequered history, it’s important to choose carefully.
1. Mortgage funds target capital stable, income-based returns from portfolios of loans secured by mortgages, one of Australia’s largest and best-performing asset classes.
2. Regular income payments.
3. Capital stable returns.
1. Be wary of funds that allow related-party transactions.
2. Avoid those with high loan-to-value ratios and lack of diversity of loans.
3. The manager’s experience is crucial.