3 OPTIONS FOR INCOME STARVED INVESTORS
Mark Lister, 26 June 2020
I’ve been getting a lot of questions about how on earth people are supposed to generate any income from their portfolios when interest rates are as low as they are.
I see the dilemma, but there’s no easy answer. The truth is, if you’re in this quandary you only have three options.
You can adjust your lifestyle and spending habits to match the lower levels of income you now receive, you can modify your investment strategy and seek out higher yielding assets like shares or property, or you can stay the course but eat into your capital to make up the shortfall.
Spending less is a valid option. Many of us spend more than we need to and would do fine being a little less frivolous. The lockdown taught us that.
Where’s the fun in that though? Especially when you’ve worked hard all your life to retire with a bit of capital behind you. What were all those years of toil for in the first place, if not to enjoy a good standard of living when you’ve hung up your boots?
The next alternative is to give up on low-yielding conservative assets and shift those funds into shares or property, both of which offer higher returns.
The NZX 50 share index is offering an annual gross dividend yield of 3.6 per cent on average, with some sectors and companies (such as listed property, utilities, or the likes of Spark) much higher than that that.
Similarly, according to the Real Estate Institute the rental yield on an Auckland property is 3.2 per cent, while some regional towns would be higher again. In addition, both shares and property have historically provided attractive capital growth on top of those income returns.
There’s a catch though. Dividends and rents are far from guaranteed, as the COVID period has proved for share investors as well as landlords.
And while capital growth is virtually assured over the long-term, during shorter periods it can be non-existent or even negative. The last thing you want is to be required to cash up your share portfolio or to sell your property during a rough patch.
Moving up the risk curve a little bit is an acceptable course of action, in fact it’s a completely logical one if you have a reasonable time horizon. Just don’t overdo it. Not every bear market will blow over as quickly as the one from February and March 2020.
This leaves us with door number three, which is to spend the income your portfolio is generating and when you need more, to eat into a little of your capital from time to time.
Many Kiwi investors are highly averse to this approach, having trained themselves to think of the capital as sacrosanct. We’ve been blessed with high interest rates for so long we haven’t needed to consider other options, and we’re determined to leave every last cent to the next generation.
We need to adjust our mindset though. The total return (which is the combination of the capital gains and the income) of an investment portfolio should be considered a pool of income available to be drawn on as required. Not just the interest or interest payments.
One of the best things about shares is their liquidity, which means you can sell small parts of your holdings with relative ease. You can’t do that with many other asset classes, and investors can use this to their advantage when managing cash flow and income requirements.
A key advantage of this approach is that there is no need to dramatically adjust your investment philosophy or risk profile, for the sake of boosting yield.
Viewing returns as returns – regardless of where they come from – means you can maintain a well-balanced portfolio of assets that matches your tolerance for risk.
And don’t worry too much about the kids, they’ll cope with a slightly lower inheritance if need be. They’ll figure it out.