21st century income generation

June 20 2013 | Category: Money advice

Investing to generate an income used to fall into the ‘straightforward and dull’ camp. Income-seeking investors would focus primarily on cash and UK government bonds or ‘gilts’ – so-called ‘safe-haven’ options that promised a relatively high income, albeit with little chance of capital growth or protection from inflation.

However, these more traditional asset classes are generating increasingly disappointing returns for income seekers. Four years of exceptionally low interest rates have crushed yields on cash deposits. Meanwhile, there are signs the bond market’s extended period of popularity could be starting to lose momentum. Although UK interest rates will at some point start to rise – thereby increasing cash yields and providing support for bond yields – there is no evidence to suggest Bank of England policymakers are in any hurry to increase rates.

On the brighter side, as times have changed, investors are no longer forced to sacrifice the long-term value of their capital in order to achieve an income. Over the years, for those comfortable enough to move further up the risk ladder, investment-grade corporate bonds and UK equities have proved fruitful strategies for income-seeking investors. In particular, an equity income approach can offered the welcome potential for capital growth as well as a sustainable income stream.

That said, although yields on UK equities continue to run well ahead of gilts, the yields offered by both asset classes have fallen over the past year. As of the end of April 2013, the UK equity market yielded 3.2%, compared with the benchmark gilt yield of 1.68%. However, a year earlier, UK equities had yielded 3.4%, while gilts yielded 2.1%.

Looking ahead, some investors may need to consider reassessing their ideas about income generation. A number of options are available, ranging from traditionally lower-risk considerations, such as cash and gilts, through UK equities and investment-grade corporate bonds, to still more speculative asset classes, such as overseas equities, high-yield bonds and property.

Taking a step up the risk ladder might sound daunting but it does not necessarily have to involve a wholesale change of approach. A controlled and well-thought-out income strategy with a robust core portfolio of relatively mainstream assets – such as gilts, investment-grade corporate bonds and high-quality equities – can be boosted by an element of exposure to more speculative income-generating investments such as high-yield bonds, say, or emerging-market equity income. As ever, diversification to spread risk across different assets remains vital.