Income investing, understood to be ‘‘basic’’ or ‘‘fixed’’, often takes a backseat in our thoughts to the fast-paced stock market, with its daily activities and promises of superior returns. But if you’re retired—or are approaching retirement —fixed-income instruments must move into the driver’s seat. At this stage, preserving capital with an assured income stream stands out as the most significant goal.
Today, investors need to blend things and get frontage to various asset classes to keep their portfolio incomes high, diminish risk, and keep their distance from inflation. Even the sage Benjamin Graham, the progenitor of value investing, advocated a portfolio cocktail of stocks and bonds for later-stage investors.
Was he alive today, Graham would likely sing the same tune, particularly since the entry of new and diverse products and strategies for income-seeking investors? So here, we’ll lay down the road map for setting forth the blueprint for a modern fixed-income portfolio.
Fixed-income appreciates in importance as you approach retirement, and capital preservation with a vouched income stream becomes a more vital goal.
Via your financial adviser
A financial adviser may aid in matching you with the appropriate investment by determining your circumstances, goals, and feelings regarding taking risks with your money. Advisers levy fees that may add up contingent upon the investment size. But, they can help take out some of the strenuous work for you by locating and validating the best types of funds per your situation.
If you lack an adviser, you can find one at unbiased.co.uk. Or you may simply call 0800 085 3250. You may also visit vouchedfor.co.uk, which permits consumers to appraise and review advisers they have used. Financial advisers are authorised by the Financial Conduct Authority (FCA).
Using a fund supermarket
If you’re confident in choosing your funds, you can do so utilising a fund supermarket. Also called platforms or discount fund brokers permit you to buy, sell, and manage shares and funds from companies and not a few diverse providers.
There are a plethora of online tools available to aid you with finding the funds to fit you. Many platforms provide access to performance figures, preferred funds, besides fund ratings. There are lots of fund supermarkets to make your selection from, so exercise your choice with caution. You ought to select per how easy the site is to use, the funds available, how much it costs, and customer service quality. At comparefundplatforms.com, you may compare providers.
Notably, you can opt to buy straight from the fund provider. Before investing in a fund, make sure you’ve read the Key Investor Information Document and the Supplementary Information Document.
Fixed-Income Investing Opportunity
This offers an opportunity for fixed-income investors since purchases may be made in the five- to 10-year maturity range, then invested again at rates current when those bonds are due. When these bonds mature is also the right time to reevaluate the state of the economy and adjust your portfolio as circumstances dictate.
Lower yields may persuade investors to take on more risk to obtain the same returns as they would have in preceding years. However, the current relationship between short-term and long-term yields also shows a bond ladder’s usefulness. Investing in eight to 10 individual issues is laddering, with one eventuating every year. This can aid you in diversifying as well as stopping you from having to predict interest rates into the future. In addition, maturities will spread over the yield curve, with chances to readjust every year as your visibility gets clearer.
Diversifying the Portfolio
Diversification is a form of risk management that ought to be in all investors’ minds. The different types of investments held in a diversified portfolio will—on average—help the investor achieve higher long-term yields.
These are often the first choice for an income investor, constituting a core holding of a general investment portfolio. They concentrate on holding companies listed on the London Stock Exchange that provide attractive income prospects. If you hold a handful of UK equity income funds, you should be able to achieve diversification from each of the individual funds’ holdings. For example, an overlay of holdings may make you more susceptible to a dividend cut. Even those who think they’re investing only in the UK are often trying out international opportunities, given that many British companies have dealings abroad. So there is a growing argument for adding extra global exposure to an equity-income portfolio. It provides a good way of allowing that your income portfolio has a healthy level of diversification.
Investment trusts are another option for income seekers. These are systematised companies that hold assets such as shares and are operated by a fund manager backed by an independent board appointed to act in the best interests of shareholders. Investment trusts can bring about consistent returns by garnering up to 15% of their dividends each year and using this money to jack up dividends in difficult years. This implies that some have very long records of elevating dividend payments year in, year out. Despite investment company boards electing to pay income out of capital in particular circumstances, even as this may abrade the long-term capital returns generated courtesy of the funds, many investors are glad to hierarchise short-term income payments.
Bond, or fixed income, funds provide an income and are popular with savers who like to count on periodic payments made for a fixed period. Governments and companies put out bonds, which guarantee a fixed income over a set number of years. Also, your capital is returned at the term’s end. UK Government bonds or ‘‘gilts’’ are more secure bond investments, given that the UK Government backs them. Corporate bonds are published by companies, come in many forms. Those with strong balance sheets are called investment-grade bonds. Companies with an elevated level of risk affiliated with them are called high yield or non-investment grade. In current times, market conditions have pushed down returns from bonds, and their value can be shredded by inflation. There are, nonetheless, ‘‘index-linked bonds’ accessible that are designed to help shield you against inflation.
Nothing like a nice piece of the property affording rich rent income to sweeten your later years. Instead of turning landlord, though, you’re better off investing in real estate investment trusts (REITs). These high-yielding securities yield liquidity, trade like stocks, and have the additional benefit of being in a particular asset class from bonds and equities.REITs diversify a modern fixed-income portfolio against market risks in stocks and credit risks in bonds.
Investing in bricks and mortar is highly preferred for income since it aids in protecting future purchasing power; property values and rents run by and large parallel to inflation. This asset class achieves ‘‘real income growth over the long term since they are handled by landlords who appreciate rents and the value rockets. Investing in a buy-to-let property is a clear choice for many, but it does leave you heavily exposed to one asset class and is expensive to get started once you factor in stamp duty and other costs. It can also be very hard to get your hands on the original capital if the market doesn’tdoesn’t permit you to sell quickly, called ‘‘liquidity risk’’. Property funds invest in real estate and can triumph over some of the liquidity risks associated with direct property investment. Whether you choose direct investment or investment in property funds, there are tax implications. A financial adviser can help walk you through the alternatives.
Tax-free income investing
Individual Savings Accounts (ISAs)
Every year the Government presents everyone with a tax-free ISA allowance. Filling up your annual ISA allowance is a must as far as savings are concerned to guarantee you maximise the tax-free opportunities. For 2015/16 the allowance is fixed at £15,240, which implies we can shelter a lump sum from capital gains and income tax. Moreover, it’s important to know that ISAs don’t offer comprehensive tax-free status for all. Income from corporate bonds and gilts (and cash) is tax-free. But income from equities can invite some tax charges as income is taxed at the source. Taxpayers can shift into higher tax brackets, so placing investments in a tax-free wrapper is a savvy move. Investing in an ISA also implies you don’t have to mention it on your tax return. Not everyone can afford to save the full ISA allowance each year, but squirrelling something away every month is better than doing nothing, especially if you start to build up your contribution over time.
Self-Invested Personal Pension (SIPP)
Your income-generating funds might also be set in another very tax-efficient wrapper for retirement – a personal pension or self-invested personal pension (SIPP). When you start taking income from pension savings, the tax treatment is a tad bit different because savers receive tax relief on the way in – it is on exit where HM Revenue & Customs takes a sliver. You get a tax recharge when you contribute to your retirement pot at the rate of 20%, 40% or 45%. So, for instance, every £800 paid in by a basic rate taxpayer will instantaneously turn into £1,000. Higher-rate taxpayers can re-claim back an additional £200 via a self-assessment form, jacking up their return even higher. To access your fund, you need to shift your money away from its tax-free wrapper. From age 55, you can generally accept up to 25% tax-free cash from your SIPP and a taxable income from the rest. Going for a share class, most open-ended funds are sold individually. Upon selecting a fund, you will be asked to choose between two types of units – income or accumulation.
Accumulation units are typically appropriate for those investors seeking growth in the value of their original investment. Any income earned is wrapped up and reinvested into the fund. Accumulation units are sought after by many investors, for example, those who work and aim to build their retirement nest egg.
For income units, any distributions from the fund are extracted and paid in cash. Income units are sought after by those who want their distributions to be paid as income—for example, those in retirement who wish to use the income earned for their living expenses.
High-yield bonds, aka’’ junk bonds’’, are another possibility via media. Truth to tell, these debt instruments providing above-market yields are very hard to invest in individually with confidence. Still, by going for a bond fund with compatible operating results, you can devote a portion of your portfolio to high-yield bond issues as an approach to boost fixed-income returns.
Emerging Market Debt
Like with high-yield issues, emerging market bonds are best invested through a mutual or exchange-traded fund (ETF). Individual issues can be illiquid and hard to research efficiently. Nonetheless, yields have always been higher relative to advanced-economy debt, offering a nice diversification that aids in deterring country-specific risks. As observed with high-yield funds, many emerging market funds are closed-end, so look for reasonably priced ones relative to their NAV.
A Sample Portfolio
A sample portfolio would give valuable exposure to other markets and asset classes. The portfolio below was made bearing security in mind. However, it is also braced to participate in global growth via equities and real estate assets investments.
Ought you to Use Funds at all?
As is apparent, we’ve recommended fund options for a handful of assets. However, deciding whether to use a fund will depend upon how much time and effort an investor is willing to devote to their portfolio—and how much they can afford in fees.
A fund seeking to throw off 5% per year in income or dividends is giving up a big piece of an already small cake, the expense ratio being 0.5%. So it makes cogent sense to keep the eyes peeled for funds with long track records, low turnover, and, above all else, low fees when taking this route.
Fixed-income investing has transformed dramatically in just a brief period of time. While some aspects have become more complex, Wall Street has registered its response by providing more tools for modern fixed-income investors to develop custom portfolios. As a result, being a successful fixed-income investor today just might imply going outside the classical style boxes and using these tools to bring about a modern fixed-income portfolio. The latter must be one that is fit and flexible in an amorphous, uncertain world.
There are risks that may be linked with each type of investment listed here—unsurprisingly. However, diversification among asset classes has proved to be a surefire way to diminish overall portfolio risk. For example, the biggest danger to an investor going after principal protection with income is keeping pace with inflation. A practical way to cut down this risk is by diversifying among high quality, higher-yielding investments instead of relying on standard bonds.