How do I generate sufficient income in a low yielding environment?

Author -  Lynette Ball

How may New Zealand investors, particularly those of us who are retired and reliant on our investment returns for our regular income, generate sufficient income in a low yielding environment?

Investment options are not helped by the fact that quality bonds – in other words investment grade bonds such as government stock or corporate debt– are not returning much more than three or four per cent at the moment, before tax. Organisations or issues that are classed as high investment grade, for example AA+, are considered to have a relatively low risk of default and often include government and local government bonds (e.g. Auckland Healthcare Services AA+ at 3.91%, Queensland Treasury Corporation AA+ 3.67% and Dunedin City Treasury AA 4.03%*).

Problem is, they’re not yielding great returns at the moment. Added to this, there is staggering amount of $6 billion corporate bonds that are maturing this year, which is putting even more pressure on the search for quality income options.

As a result, some Kiwis are turning to high yielding dividend NZ shares to make up the difference, but whether this is a viable strategy depends on a number of factors, including the age and circumstances of each individual investor and their tolerance towards more volatile investments.

Authorised Financial Adviser and a Certified Financial Planner (CFP), Lynette Ball, says the danger is that in trying to achieve better yields you may end up with a less diversified portfolio and consequently too much exposure in one segment of the market, such as an overexposed position in New Zealand Equities. This could also result in investors having an increased concentration of a smaller number of companies, because minimum brokerage costs and/or purchase sizes limit their ability to diversify. Consequently, investors need to consider that although they produce a better dividend, shares carry more volatility.

“Of course everything carries a risk – there’s no such thing as a free lunch – but the risks do pick up substantially when adding shares to your portfolio. However, if you are unable to meet living expenses on your interest alone, by not adding growth investments, you could start eating up your capital and potentially run out of funds.”

The best tactics to limit risk while generating sufficient income in a low yield environment will absolutely depend on your personal circumstances, but speaking broadly, may include:

  1. Three-baskets approach;
  2. Utilising short durations bonds;
  3. Tapping into principal.

1. Three-baskets approach:

Spicers is very focussed on keeping investment portfolios well diversified and the three basket approach helps achieve this:

  • Basket 1 – Containing emergency funds;
  • Basket 2 – A cash basket that provides one to three years income;
  • Basket 3 – Containing a balanced investment in a diversified portfolio over a longer term. Here the yields earned are transferred back into Basket 2 to top up this basket, and if it isn’t generating sufficient yields, capital is disinvested periodically.

The type of investments for basket 1 and 2 would be high interest cash accounts or term deposits.

Not much explanation is needed for how to invest your money in term deposits, with a range of providers offering fixed interest rate options over varying short term periods. Again it is a question of your risk preferences and personal circumstances and how those relate to your income requirements.

The type of diversified portfolio described in basket 3 may include a number of components, including New Zealand and global bonds, property (New Zealand and global), infrastructure, commodities, global and New Zealand equities and cash.

The percentage invested between low risk investments, such as high quality bonds issued by city councils and large corporates, and higher risk investments, like high yielding dividend shares, will depend on your individual circumstances as mentioned earlier in this piece e.g. your age, and also your risk profile.

A balanced investor, however, may look for a 60 – 40 split between growth investments (for example shares and property) and income investments (for example cash and bonds), whilst a more conservative investor would have a split of 30 – 70 between growth and income assets.

2. Utilising short duration bonds:

For the bond component of a diversified portfolio you could consider bonds with a short duration (maturity). Economists have been suggesting that interest rates will need to increase, therefore by holding bonds with a shorter duration you will be able to enjoy increased yield sooner. As these assets form part of your longer-term portfolio, these dividends can then be invested in the income basket as a way to constantly be re-balancing the baskets.

3. Tapping into principal:

Whether or not tapping into your principal is a viable strategy largely depends on how much money you need and for how long. If, for example, you know that your investments will run out but you still own your family home, then by selling down and freeing up capital you can still provide your income for the remainder of your life. In this instance, drawing on the principal may work for you.

“If you have to accept that you just won’t get sufficient income from your investments and need to draw down on your capital – while still maintaining a conservative investment strategy with not a huge amount of volatility – it is a good idea to work with a financial adviser to do some forecasting to make sure you can make your money last. A review should be undertaken annually or as your circumstances change.” says Lynette.

The important thing to remember is that your individual circumstances, goals and risk preferences are unique to you, and the best action you can take is to sit down with a Spicer’s Adviser to review your situation and discuss the best way forward to achieve the best possible outcomes for you – rain or shine.

 

*ASB Security NZ Fixed Interest Summary 7 April 2015

How do I generate sufficient income in a low yielding environment?

How may New Zealand investors, particularly those of us who are retired and reliant on our investment returns for our regular income, generate sufficient income in a low yielding environment?

How may New Zealand investors, particularly those of us who are retired and reliant on our investment returns for our regular income, generate sufficient income in a low yielding environment?

Investment options are not helped by the fact that quality bonds – in other words investment grade bonds such as government stock or corporate debt– are not returning much more than three or four per cent at the moment, before tax. Organisations or issues that are classed as high investment grade, for example AA+, are considered to have a relatively low risk of default and often include government and local government bonds (e.g. Auckland Healthcare Services AA+ at 3.91%, Queensland Treasury Corporation AA+ 3.67% and Dunedin City Treasury AA 4.03%*).

Problem is, they’re not yielding great returns at the moment. Added to this, there is staggering amount of $6 billion corporate bonds that are maturing this year, which is putting even more pressure on the search for quality income options.

As a result, some Kiwis are turning to high yielding dividend NZ shares to make up the difference, but whether this is a viable strategy depends on a number of factors, including the age and circumstances of each individual investor and their tolerance towards more volatile investments.

Authorised Financial Adviser and a Certified Financial Planner (CFP), Lynette Ball, says the danger is that in trying to achieve better yields you may end up with a less diversified portfolio and consequently too much exposure in one segment of the market, such as an overexposed position in New Zealand Equities. This could also result in investors having an increased concentration of a smaller number of companies, because minimum brokerage costs and/or purchase sizes limit their ability to diversify. Consequently, investors need to consider that although they produce a better dividend, shares carry more volatility.

“Of course everything carries a risk – there’s no such thing as a free lunch – but the risks do pick up substantially when adding shares to your portfolio. However, if you are unable to meet living expenses on your interest alone, by not adding growth investments, you could start eating up your capital and potentially run out of funds.”

The best tactics to limit risk while generating sufficient income in a low yield environment will absolutely depend on your personal circumstances, but speaking broadly, may include:

  1. Three-baskets approach;
  2. Utilising short durations bonds;
  3. Tapping into principal.

1. Three-baskets approach:

Spicers is very focussed on keeping investment portfolios well diversified and the three basket approach helps achieve this:

  • Basket 1 – Containing emergency funds;
  • Basket 2 – A cash basket that provides one to three years income;
  • Basket 3 – Containing a balanced investment in a diversified portfolio over a longer term. Here the yields earned are transferred back into Basket 2 to top up this basket, and if it isn’t generating sufficient yields, capital is disinvested periodically.

The type of investments for basket 1 and 2 would be high interest cash accounts or term deposits.

Not much explanation is needed for how to invest your money in term deposits, with a range of providers offering fixed interest rate options over varying short term periods. Again it is a question of your risk preferences and personal circumstances and how those relate to your income requirements.

The type of diversified portfolio described in basket 3 may include a number of components, including New Zealand and global bonds, property (New Zealand and global), infrastructure, commodities, global and New Zealand equities and cash.

The percentage invested between low risk investments, such as high quality bonds issued by city councils and large corporates, and higher risk investments, like high yielding dividend shares, will depend on your individual circumstances as mentioned earlier in this piece e.g. your age, and also your risk profile.

A balanced investor, however, may look for a 60 – 40 split between growth investments (for example shares and property) and income investments (for example cash and bonds), whilst a more conservative investor would have a split of 30 – 70 between growth and income assets.

2. Utilising short duration bonds:

For the bond component of a diversified portfolio you could consider bonds with a short duration (maturity). Economists have been suggesting that interest rates will need to increase, therefore by holding bonds with a shorter duration you will be able to enjoy increased yield sooner. As these assets form part of your longer-term portfolio, these dividends can then be invested in the income basket as a way to constantly be re-balancing the baskets.

3. Tapping into principal:

Whether or not tapping into your principal is a viable strategy largely depends on how much money you need and for how long. If, for example, you know that your investments will run out but you still own your family home, then by selling down and freeing up capital you can still provide your income for the remainder of your life. In this instance, drawing on the principal may work for you.

“If you have to accept that you just won’t get sufficient income from your investments and need to draw down on your capital – while still maintaining a conservative investment strategy with not a huge amount of volatility – it is a good idea to work with a financial adviser to do some forecasting to make sure you can make your money last. A review should be undertaken annually or as your circumstances change.” says Lynette.

The important thing to remember is that your individual circumstances, goals and risk preferences are unique to you, and the best action you can take is to sit down with a Spicer’s Adviser to review your situation and discuss the best way forward to achieve the best possible outcomes for you – rain or shine.

 

*ASB Security NZ Fixed Interest Summary 7 April 2015

How do I generate sufficient income in a low yielding environment?
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The content on this website is for information only. The information is of a general nature and does not constitute financial advice or other professional advice. Before taking any action, you should always seek financial advice or other professional advice relevant to your personal circumstances. While care has been taken to supply information on this website that is accurate, no entity or person gives any warranty of reliability or accuracy, or accepts any responsibility arising in any way including from any error or omission. A disclosure statement is available from your adviser on request and free of charge.

 

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