The search for income is a major driver for many Australian investors, particularly those who have retired and/or who are running a Self-Managed Superannuation Fund.
As official interest rates have slipped over the last decade from 7.25% to a record low of 0.75%, it has become more difficult to generate income. Here is a snapshot of the current climate and some considerations for investing.
The move away from Term Deposits
Income-seeking investors have usually looked to term deposits, but term deposit and savings account interest rates have decreased also. As of late January 2011, a one-year term deposit had the potential to earn 6.15% from a major bank, and now, the average one-year term deposit rate is 1.5%. This rate is lower than the 6-month term deposit rate of 1.6%, showing a market expectation that rates are going to continue to fall. This is driving income-oriented investors to look elsewhere.
Risk versus Reward
The variability of returns for taking on more risk while chasing yield can sometimes push investors further up the yield curve than they prefer. Let’s have a quick look at the basic investment yield curve (below):
As investors take on more risk they can expect an increased return in the long run. However, in the short to medium term, they should be prepared to experience some volatility. That is why time in the market is so critical.
Fixed rate bond portfolios have rallied hard this calendar year and potentially taken some future gains with them. Although they have previously acted as a good buffer from share market corrections, there is some discussion that this might not be the case going forward, or that the buffer is not as large compared to the past. Floating rate bonds reduce the interest rate risk when interest rates start to climb. However, there is less opportunity to pick up a buffer during market corrections or potentially no opportunity at all.
With bonds now yielding as low as 1.5-3%, investors are looking to diversify investments into other areas
There has been an increase in investments in the unlisted sector – private equity, commercial property and mortgage backed securities. These are potentially worth including in a portfolio, as long as the investor has an understanding of the time frames and liquidity requirements of the investment. There may be penalties to pull the funds out early, restricted withdrawal opportunities, or additional fees may apply.
Attractive growth and yield from equity markets
Australian and Global equity markets are close to record highs but offer reasonable yield in comparison to bonds, plus the added benefit of franking credits from Australian equities. This is a good long-term strategy and investor portfolios have benefited from being in equities. Having the ability to ride out any market corrections and being prepared to invest for a minimum of 5 years is important, but the growth and yield reward will certainly be attractive in the long run.
Growth portfolio assets in the long run are still expecting a 6-8% annual return. 20 years ago, defensive portfolios were returning 6-8%, however they are now expecting to return closer to 2-4%, while we see interest rates remain lower for longer. Great if you are like us, net borrowers!
What are safe yielding assets?
Unfortunately there is not one answer to this question. There are many considerations including your investment time frame, your investment objectives and your willingness to potentially accept more risk.
Due to the topical nature of this issue, Allan Hall will be hosting a free seminar, aimed at our retiree client base to further discuss these issues and their impact for pension income streams and also estate planning considerations. Further information for the seminar and registration details will be sent out shortly to all Allan Hall clients.
If you require more information or assistance regarding investing for income and interest rates, or any queries in the areas of wealth accumulation, retirement planning, wealth protection, superannuation, investments and personal and business insurance, please contact Allan Hall Financial Planning directly using the button below.
This is general advice only and does not take into account your financial circumstances, needs and objectives. Before making any decision based on this article, you should assess your own circumstances or seek advice from a financial adviser and seek tax advice from a registered tax agent. Information is current at the date of issue and may change.