MANY investors these days are in search of income. People moving into retirement want investments offering a stable income and reasonable security of capital.
Look at what is happening in the UK and try to apply some common sense: we’re living longer; our savings rates have dropped; residential property has stopped climbing at double-digit rates (it had to happen); defined benefit schemes, that fix your retirement income, are disappearing; stealth taxes keep rising.
That leaves much of the population with a basic issue – “Where is my retirement income supposed to come from?”
Most of us, from a personal financial viewpoint, migrate from accumulating capital, to needing income. Financial planners will help their clients in their pre-retirement years calculate how much capital is likely to be required to fund later years. The need to build capital begins to shift to a need for income generation as retirement approaches. This income will need to grow in pace with inflation. It would be simple if you could take your savings and put them in low-risk vehicles such as cash that would in turn produce the funds required to support your lifestyle forever. But that is rarely possible. Firstly, inflation tends to erode the purchasing power of cash, and secondly, the near risk-free rates of return are seldom sufficient to produce enough income.
Let’s go back to the common sense bit. The rules that should be followed when constructing investment solutions are: diversify to reduce risk; watch costs, particularly in a low-growth environment; consistent stable performance eventually wins; don’t just set it up and forget about it, review it.
Diversifying the portfolio is key and can be accomplished in a couple of ways, usually by selecting multiple asset classes, including cash, regions and styles. We also need to be aware of the investment vehicles we choose, and their characteristics such as liquidity, tax and general risk parameters.
A cornerstone of a portfolio that seeks to generate income while preserving capital will naturally be bonds. However, including other asset classes such as cash, equities and commodities achieves diversification and creates the opportunity for some capital appreciation to cover costs and allow for modest growth to fight inflation. Diversification is valuable if the assets are not highly correlated. That means that their prices tend not to go up and down together. This in turn reduces overall portfolio volatility, which is a measure of risk.
There will always be challenges that make the trade-off between risk and return so important and so subtle in income investing, just as in other forms of investing. Expectations for how much income can be generated without taking unwise risks needs to be realistic – but the seeds can be planted now for a robust portfolio that can continue to generate attractive levels of income and adapt to changing markets over time.
The key is to take advice where- ever possible and in our opinion it should be from an independent financial adviser who can provide advice from the whole of the market, rather than perhaps one that is tied to a particular provider.
• Chris Malcolm is a director at Kelvin Financial Planning
Search for a job
Search for a car
Search for a house
Weather for Edinburgh
Thursday 23 May 2013
Temperature: 5 C to 10 C
Wind Speed: 23 mph
Wind direction: North west
Temperature: 4 C to 13 C
Wind Speed: 17 mph
Wind direction: North east