Structuring your investment portfolio throughout life
If low interest rates continue to remain, it really matters where you invest your money. Investing for income means choosing assets that are able to provide you with a regular income. This is in contrast to investing for growth, which focuses on how much your assets could gain in value.
People are living longer. Simple demographics mean that supplementary income is no longer a luxury, it’s a necessity. With historic ultra-low interest rates on savings, many investors over the past decade have turned to income-paying funds as an alternative to cash-based savings.
Changing life plans and priorities mean we now encounter varying income needs and goals throughout our life – and when investing, certain innate behavioural traits will influence our decision-making.
Increasingly, some income seekers are looking beyond cash and government bonds to capitalise on the more attractive income opportunities that exist across global markets. Investing in higher yielding assets – such as dividend-paying stocks, corporate bonds and emerging market debt – can provide an attractive income, even with interest rates so low.
Our reasons for seeking income tend to shift through life. Shorter-term goals like supporting a business start-up or funding children’s education may be a priority in earlier years, before making way for a longer-term focus on boosting retirement income and providing an adequate cushion for later life. The key is working out how much income you need at each stage, and then finding an appropriate investment strategy to help you meet your goals.
It’s essential to work out what you need to achieve and set clear objectives. The most obvious option to generate a monthly income is to buy funds that do just that. Some funds explicitly set out to provide investors with a monthly income, while others – such as many property funds – pay out dividends monthly, too.
With time on your side, there are steps you can take to reduce risk, particularly in the final years before you need the money as your focus shifts from capital growth to capital protection. In order to achieve your financial goals, you can build a balanced portfolio incorporating a variety of different investment types (including cash and funds that invest in everything from corporate bonds to FTSE 100 companies, smaller companies, and companies based in numerous countries across the world) or you can simply pick one fund that is itself a balanced portfolio and offers you access to a broad spread of investments through one single plan.
However, if you are seeking income from your investment straight away, you may need to ensure your investments immediately generate the sum you need, so it’s worth factoring this into any decision-making. It may well be that your decision does not involve whether or not you should invest in the stock market, but which particular stock market investment will help you generate the income you need.
There are various ways in which capital can be used to generate income. Each has its pros and cons, and for most people the ideal solution, where possible, is to spread money among several different types of investments, providing a balance and diversifying risk.
Here, we look at some potentially income-boosting investments. Always remember to ensure you have a suitably diversified portfolio. You should never just rely on one asset class or investment, as if this investment suddenly falls in value, you stand to lose more than if you had put your money into a range of different investments.
Banks and building societies
Savings accounts have traditionally been a clear favourite for many people who rely on the interest payments as a supplementary income. Deposits are seen as a secure option because the monetary value of savings does not go down, and there is protection under the Financial Services Compensation Scheme for deposits up to £85,000 in any one institution should they not be able to meet their commitments.
However, interest rates fluctuate, so the income from savings accounts cannot be relied upon to remain stable. Not only do the returns depend upon the general level of interest rates (which has only fallen over the last decade), but banks and building societies are also able to apply their own discretion to the interest they pay on their accounts. Rates are often inflated by introductory bonuses which then fall away, typically after a year. Inflation can also erode the value of cash on deposit.
Fixed income securities/bonds
A bond is a loan that the bond purchaser, or bondholder, makes to the bond issuer. Governments and corporations issue bonds when they need to raise money. An investor who buys a bond is lending money to the government or corporation.
Like a loan, a bond pays interest periodically and repays the principal at a stated time, known as the ‘maturity date’. Certain government securities are regarded as the most secure, though corporate bonds can pay higher rates of interest depending on the deemed creditworthiness of the issuing companies. Over the long term, shares have tended to provide a greater total return, but bonds are generally regarded as less risky. In the event of bankruptcy, a bondholder will get paid before a shareholder.
By investing in equities, savers can back companies which have potential to pay out significant dividends – a share in the profits – to shareholders. There are many such companies which have historically provided not only reasonable dividends, but a track record of growing profits and consequently improving those dividend payments over time.
It is also possible to grow your original capital if the share price increases in value over the time you are invested, although it may go down as well as up along the way. Investments in equities can be volatile. Their values may fluctuate quite dramatically in response to the results of individual companies, as well as general market conditions.
In recent years, there has been a growing demand for rented property, as the cost of housing has risen. Many investors have profited from the buy-to-let market, buying residential property that they then let out in order to generate a rental income. However, property is not as liquid an investment as some others. There is also the risk of periods without income between lets and the ongoing costs of maintaining the properties.
More significantly, the taxation burden on UK buy-to-let investors and the properties themselves increased in 2016 following a government clamp down. There was a sharp increase in stamp duty payable by homeowners purchasing a second home, as well as an increase in the level of taxation faced by landlords buying to let.