Written by Michael Karagianis, Senior Investment Strategist, MLC

‘With returns from cash and bonds falling, investors need to look for other ways of generating more sophisticated strategies to deliver reliable income and capital security.’

Since the global financial crisis (GFC) there’s been a surge in the popularity of investments that provide a reliable income stream. A long period of increased market uncertainty has tended to make investors risk-averse and conservative about their choices.

In Australia, demand for term deposits has soared, helped by attractive interest rates. Investors’ desire for predictable income and capital security has also led to a boost in demand for other income-based investments, especially bonds.

Chart 1 shows how the financial assets of Australian households have changed since the GFC.

Chart 1: Australian households have moved away from shares into bank deposits since the GFC

Income-based investments such as term deposits and bonds are also popular because of our aging population. Retirees need to draw down savings to meet lifestyle costs and there is a risk their savings won’t last throughout their retirement. For both reasons, investment strategies that deliver more predictable returns with lower risk are attractive to Australian retirees.

March 2013

Investment newsIncome investing: beyond cash and bonds

Term deposits and bonds may not deliver

However, interest rates are now so low that term deposits and bonds alone are unlikely to meet retirees’ needs throughout retirement. After the last cut in official interest rates in 2012, term deposit rates dropped to around 4%. This is too low to both provide adequate lifestyle income for retirees and compensate for inflation. Chart 2 shows the recent slump in bank term deposit rates. Returns from bond investments have also started to decline, reflecting the low bond yields.

Chart 2: Australian bank deposit rates have continued to decline

More diversified income investments are needed

Given the decline in term deposit rates and bond yields, a portfolio needs to include a wider range of income-generating investments in order to deliver both predictable income and a reasonable degree of capital stability. Here are some other strategies to consider.

Income from shares – shares that pay a high dividend can deliver stable income flows. When dividends are franked, they can be very tax effective. For example, Australian banks are offering around 6% pa fully franked dividends, which grosses up to around 8.75–9% pa for retirees. However, share dividends are still exposed to share price movements.

Absolute return investments – the manager has flexibility to choose the types of assets they invest in. This means there is the potential to deliver a more even income stream in a range of market conditions.

Alternative assets – this term covers a very wide range of assets that don’t fit in the traditional asset classes of shares and bonds. Just some examples are hedge funds, residential and commercial property, infrastructure and private equity.

When traditional assets are highly volatile (such as shares) or have declining returns due to falling interest rates (such as cash and bonds), alternative assets can:•increase diversification in a portfolio, producing a different pattern of investment returns, or •provide a higher return to compensate for the investment being less easy to sell.

Corporate bonds – these are a potential building block in an income-oriented portfolio because they have higher interest rates than government bonds.

The right solution needs the right combination of strategies

These types of investments can expand the options for retirees seeking a more stable pattern of income and other investors looking for reasonable returns with lower capital risk.

Speak to your financial adviser about the combination of investments that’s right for you.

Investment newsIncome investing: beyond cash and bonds

Investment newsIncome investing: beyond cash and bonds

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