Investment news
Income investing: beyond cash and bonds
March 2013
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 riskaverse 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.
Investment news
Income 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 news
Income investing: beyond cash and bonds
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