There are lots of different ways to generate income. The approach depends on what type of income you want, how often you want to receive it and what the market conditions are.
If you want to increase the income over time you’ll want to invest in a way that encourages the capital to grow. This will allow the income to rise as well and also combat future inflation.
If you want a high income now, then a greater allocation to ‘income producing assets’ such as bonds and cash deposits might be wise, but that may come at the cost of capital growth. The more income you expect to receive, regardless of where you invest, then the greater the potential risk to your capital.
INCOME INVESTING – LEARN FROM HISTORY
Why is it important to increase future income?…
… Goods and services costing £1 ten years ago will now cost £1.31.
This tells us that retail prices (UK inflation) grew by 2.8% on average for each of the last ten years.
This means that had you received interest from your bank and spent it, the remaining capital in real terms would now be worth just three-quarters of what it was.
Who was it that said in 1967 “the pound in your pocket will be worth more tomorrow”? Answers on a postcard please!
INCOME INVESTING – A GROWING INCOME
There are lots of assets capable of generating income, such as bonds (through the coupons on the loans), equities (through dividends) and property (through rental yield).
The key thing is understanding the risks of each, but not only that, what factors affect income and how it is likely to vary through a typical economic cycle.
As a general rule, equities tend to anticipate which means they sell off ahead of an economic downturn, whilst property tends to lag, therefore, capital values suffer as a result later on.
Whatever type of income you are looking to generate most people want to install stability through their approach to investing and to do this diversifying across a range of ‘assets’ to protect your portfolio at certain stages in the cycle.
If your eggs are all in one basket, your income will be at risk. It is therefore important to invest globally, to limit the impact of variations across economic cycles and the effect that this can have on investments locally. One thing worth bearing in mind is that any source of income has risks – look at the banking sector in 2008 – and, bank interest rates collapsing, so we need to minimize these risks as far as possible.
The key to generating a more stable yield from income investing is to diversify in to different types of assets such as equities, bonds and property as well as cash deposits.
All assets have been under pressure because of the credit crunch and, in addition, the fact that interest rates are at historic lows. Having some other assets in your portfolio will help diversify, even if they don’t contribute to yield (income) at present, they should help with capital growth.
Investing in income is like investing anywhere else, you must buy at the ‘right’ price. Assets with different characteristics will help to smooth your overall returns and encourage your capital to grow which, in turn, will improve the certainty of your future income.
INCOME INVESTING – EQUITIES (SHARES)
The sell-off in equities has seen the dividend yield (income) rise, however, because of the issues companies are having refinancing their debts, dividend payments are under pressure.
In the good times companies will finance dividends through debt, in recognition that dividend growth makes their shares attractive.
In the toughest of times though, they must use their cash flow to finance their businesses, which means that payouts to shareholders get put into second place and dividends are more likely to be cut.
Companies are tightening their belts just like individuals. This means that when looking for income investing, selecting the right companies to invest in is critical. Those with healthy cash flows have more chance of sustaining their dividends.
INCOME INVESTING – BONDS
This is an interesting area at the moment. The income from corporate bonds (loans to companies that generate coupon payments for investors) is attractive when compared with interest rates. There is room for capital appreciation given the sharp sell-off we’ve seen in recent months.
There are some big moves in currencies as investors try to establish a rational base line for exchange rates.
We’ve seen big moves in sterling and the effects that this can have to the price of goods generally.
It is no different for investors, in that the relative change in currencies can actually be more important to your results than the performance of the asset you invested in.
Specialist bonds like high yield and emerging markets are also interesting income investing options and are offering attractive income yields.
For example, the income from emerging market debt being well over ten percent above US government bonds.
INCOME INVESTING – PROPERTY
Historically an attractive asset, however, capital values have fallen.
By using a range of approaches to invest in property around the World, where not every economy is contracting like the UK, returns can be improved upon.
Remember, property will always continue to be a sound long-term income investing option and the risk of missing the upturn should be considered.
However much an asset class will be out of favour in the short term, the sensible way to income investing is to be pragmatic.
Chances are that things are neither as good nor as bad as the prevailing view of the herd, so invest with a longer-term view and enjoy the returns of a truly diversified portfolio.
Robin’s a professionally-qualified financial advisor, his
company having some 40 regulated advisors throughout
the EU. If you’d like to ask him a question, or contact
him to discuss financial or investment matters in
confidence, please fill in the short form on this page.
MORE INVESTMENT ARTICLES FROM ROBIN …
- The Spanish Inheritance Tax (Guide & Advice)
- Ten Best Investment Ideas in Spain
- Spanish-Approved Investment Bonds (Part 2)
- Spanish-Approved Investment Bonds (Part 1)
- Qualifying Recognised Overseas Pensions Scheme (QROPS)
- Protecting Your Spanish Savings (Secure Your Future)
- Making a Spanish Will (Advice for Expats)
- Investing is Like Golfing (Free Financial Tips)
- Income Investing in Spain
- Deposit Account Alternatives in Spain