Where has all the income gone?

By Sarah Jouhal, Director Wealth Management Alexander Forbes Offshore

Before the global financial crisis in 2008, investors looking for income could find it relatively easily. In April 2008 interest rates[1] were cut to 5% so if you left your money on deposit with a bank, you could achieve a return of up to 5% a year. In March 2008, inflation was running around 2.5%[2], so you would have stayed ahead of rising prices too. Unless your bank went bankrupt (and none of them in the UK did) then this was a very low risk investment, with low or no fees.

At the same time, bond[3] prices, which are also based on interest rates, were offering 4.6% for a UK government bond and for a little more risk, around 6% from high-quality corporate bonds.[4]

For investors today, the investment landscape for income is very different

Interest rates in the UK currently stand at 0.1%, so deposit rates at the bank are minimal, with only special saver rates offering over 1% a year. Government bonds are offering negative interest rates in some cases, meaning you are in effect paying to lend your money to the government. 

Many investors have benefited from company dividends[5] in their equity portfolios. Dividends from the largest UK companies have been averaging 4–6%[6] a year for a number of years.

This seems to be a good choice for investors willing to take slightly more risk, but the current global pandemic has caused some companies, including banks and insurance companies, to stop or suspend their dividends as they hold onto cash in this crisis. This naturally means that, at least in the short term, dividends will be lower.

In 2020, investors may be thinking that it is impossible to find natural income for their portfolio without taking a great deal of risk and they are probably right. There is no ‘magic income tree’ that I have come across in 29 years of helping clients with their investments. The fact is that when interest rates are low, the amount of income your investment can earn is low.

So what can you do?

If you need to take money out of your investments regularly, you need to re-frame your investment requirements. Focus on the total return from your investment. This should be a mixture of capital growth (where the price rises over time) as well as income. Many income investors are uncomfortable with the lack of certainty that this brings, so a little planning is in order.

A ‘safe’ rate of withdrawal

Start with how much you want to spend. If you withdrew 2% of your total investments each year, would that be enough for the spending you are planning? 

As financial planners we would always say keep some cash for emergencies – around 3 to 6 months’ salary is the general ‘rule of thumb’.

The question is, what total return do you need on your investment to give you that amount of money to spend?

Don’t forget the following:

• Charges – the cost of investing 
• Inflation – which increases prices over time 
• Tax – this depends on your own circumstances and how your investments are run

Add these costs to your desired return to get to the total that you ‘need’ each year.

How could you achieve that return?

We can recommend the most suitable diversified portfolio for you, from a range of selected professional investment managers. It is extremely important to minimise your risk by diversifying your portfolio using different styles and strategies, so don’t put ‘all your eggs in one basket’. Buying just one or two income stocks, or one income fund, is potentially a high-risk approach.

We can help you set a realistic target return that your investment can earn.

Thinking about the risks

When investors consider risk, it is usually the risk of stock markets going up and down. 

What about running out of money in retirement? If you take out too much money in the early days of your pension or investment, this might be a risk if you are relying on bank interest alone.

What about ‘eating into your capital’, which is the main reason you are taught to look for ‘only income’ when withdrawing money from your investments? Clearly if your investment goes up by 2% in the year and you withdraw 3%, you will be taking 1% more than your investment has ‘earned’. 

As long as you don’t take out more than your investment has earned, you will continue to enjoy rewards from your investments for many years to come.

The key to total return investing is to use a financial adviser to help you with the following:

• Ensure you have a diversified portfolio.
• Understand how easy it is to sell up if you need to. 
• Set a return that you think is reasonable and review it at least once a year. 
• Understand how you are invested so you know you won’t lose all your money overnight. Know that the stock market goes up and down all the time.
• Avoid panic if the market suddenly falls, as it did very steeply in March this year. Always keep enough cash for emergencies.
• Keep your investments working to earn the return you need to ensure your financial well-being.

If, like other investors you have been struggling with income, speak to a qualified financial adviser today. 

Contact us: +44 1534 837837 or advice@aforbes.co.je

Prices can fall as well as rise and you may not get back all your investment, which depends on market movements.