Take the Income Challenge
Generating an income is one of the most constant demands placed on our capital, and yet the questions posed by the savings and investment landscape remain as challenging as ever. From the wide range of savings and investment plans to choose from and which features to consider, to the greater freedom available from ISAs, it is more important than ever that all options are considered carefully. But where do you start? We take a quick tour around the current challenges being faced by income seekers as well as highlight some of the more popular savings and investment options being used by our customers.
The here and now
For income seekers, the aftermath of the global financial crisis is still very much upon us as the period of record low interest rates continues and historically low savings rates hamper cash savers to achieve returns anywhere close to those seen in previous years.
Although inflation has fallen back to below the Bank of England’s 2% target, considerable uncertainty still remains around the impact inflation could play in the coming years and with economic indicators still hazy in forecasting a continuous upward trend, this is indeed a challenging time. Combined with lower incomes, reduced retirement provision and record low annuity rates and those affected most are indeed savers and investors seeking income, whether you are still in work or retired.
Interest rate rises could be further away than you think
With the move away from using unemployment figures as a yardstick for potential rate increases, the Bank is now pointing towards a more balanced growth in the wider economy before any suggestion that we are in a sustained recovery within which interest rates might then rise. The Bank of England is now predicting GDP growth of 3.4% for 2014, and with other economic data such as unemployment figures also improving, the consensus is that rates could start to rise from mid 2015 onwards, and the Bank of England Governor Mark Carney has said the base rate of interest could be as high as 3% by 2017.
However, this is not a view shared by all. Star fund manager Neil Woodford who recently moved from Invesco Perpetual to set up his own fund management business, takes a different view: “I am more cautious on growth in the UK than the crowded consensus. The economy has not normalised, and I do not yet see scope for the current rate of UK growth to be sustained” he said. “Therefore I am much more cautious on when rates will rise in the UK. It is further away than people think and I can easily envisage an environment where interest rates do not go up in the next two to three years.”*
Income remains a top priority
The other point to remember is that even if rate rises occur, be it sooner or later than expected, there is no guarantee that savings rates will follow suit and given the number of rate cuts in the meantime, how long would it actually take for savings rates to return to their previous highs? Perhaps the more important question to consider is ‘will they ever?’
Whether you are an experienced investor or new to saving for the future, those needing income from their capital covers a wide range of scenarios, some of which may apply to you right now:
- I am working and need to supplement my income
- I am retired and need an income from my savings
- I have an instant access Cash ISA but the level of interest has dropped significantly
- I have an Investment ISA that is not yielding what it used to
- I have a maturing fixed rate Cash ISA and the equivalent rate is significantly lower for the same term again
- I would like a fixed and regular income from my capital
What is clear is that regardless of the prevailing economic conditions, income remains a top priority for many.
ISA changes to the rescue…
By contrast to the interest rate environment, there is some better news for savers as the Budget has added a string to the income seeker’s bow with the changes to ISAs that take effect on 1st July. Not only does the overall ISA allowance increase to £15,000 per tax year, but importantly the distinction between Cash ISAs and Investment ISAs (or Stocks & Shares ISAs) is removed since you can place up to the full allowance in one or a mixture of both – it will be up to you how much of this you put into cash and investments.
Crucially this means that for the first time, Investment ISA portfolios can be moved into Cash ISA products. However, this also means that even more money could end up with banks and building societies as investors look to rebalance ISA portfolios – just at a time when they do not want your money and continue to offer record low savings rates to both new and existing customers. So although greater freedom and choice is welcome, this also poses more questions for us to consider. The bottom line here is you need to think through your options in greater detail than ever before.
Savers and investors need help
Whether it’s a fixed or variable income, capital protected or capital at risk, or knowing how long you are able to tie up your money for, these are all questions that need to be carefully thought through, and that’s before you even start to look at the options available. From fully capital protected bank deposits paying a fixed or variable rate of interest, a capital at risk investment paying a variable income and everything in between, the options are vast and savers and investors often need help in knowing where to start. So how do you take the income challenge?
First things first – to risk or not to risk?
Perhaps the most important consideration and one which should be considered first is whether you wish to expose your capital to risk, or whether a return of at least your original deposit is your top priority. The principle of risk versus reward means that higher potential returns only become available by moving up the risk ladder, but it should be noted that risk covers a broad spectrum.
If you are looking for the potential for higher returns from your savings, then you should be prepared to tie up your money since there is no increased reward without increased risk and when looking for income solutions this usually equates to longer terms being necessary. This must also be considered in the context of the current economic conditions, for example the impact inflation can have on the real value of your money.
Capital protection
If capital protection is top of your priority list and you are prepared to tie up your money for a set period of time, the default option for savers has traditionally been the fixed rate bond. These offer a choice of fixed terms, generally between 1 and 5 years in length, with current rates ranging from just under 2% for a one year fixed rate, increasing to around 3% if you commit for five years.
Many fixed rates have fallen by more than half in the last few years, whilst tax payers still need to earn more than 2% to beat the current headline rate of inflation. With instant access losing you money in real terms and fixed rate bonds not offering much of a premium for tying up your money, even if you think that inflation could average below the Bank’s 2% target for the coming years, it only takes a small increase and suddenly you could be losing significant amounts in real terms.
Moving up the risk spectrum
The only alternative to accepting losing money in real terms is to move up the risk spectrum and with the relaxation around the movement between Cash ISAs and Investment ISAs helping to remove some of the cash versus investment ISA debate, there is now an opportunity and a need for savers to really consider their options very carefully indeed.
A middle ground
Instead of making the full leap from cash to investments, structured deposits offer the potential for stock market linked returns but without risking your capital. The deposit provides the capital protection, whilst linking your return to the stock market (normally the FTSE 100 Index) replaces a fixed rate of interest with the potential for a higher return. Combined, these plans offer a middle ground between a traditional fixed rate bond, where your capital and return is guaranteed, and an investment where your return is not guaranteed and your capital is at risk.
One of our most popular is Investec’s Target Income Deposit Plan which offers a potential income of 4.75% per annum dependent on the performance of the FTSE 100. This income is therefore not guaranteed although the plan does have a memory feature which offers the potential for any missed payments to be paid at a later date.
Higher returns
For those prepared to accept some risk to capital, there are a wider range of options available and this is where the potential for higher income yields can be achieved. Inevitably this involves exposure to the stock market and aside of investing directly in shares or bonds, there are two main ways to invest.
Defined return, defined risk
For those looking for the potential for higher returns and who are prepared to put their capital at risk, the choice of investments available is vast. Our most popular investments are fixed term investment plans offering a defined return for a defined level of risk, so you know up front exactly what has to happen in order to achieve the income on offer.
Our most popular income investment is a unique fixed income plan which offers a high level of fixed income (currently 5.52%) for a fixed term so investors know exactly how much they will receive, when and for how long. Other popular investments include a variable income plan based on the performance of four FTSE 100 listed shares offering up to 9.04% income each year and quarterly payments.
Some capital protection against a falling market
These investments also include what is known as conditional capital protection which means that your initial capital is returned at the end of the investment term, as long as the underlying investment (either the FTSE 100 Index or shares listed on the Index) has not fallen by more than 50% of its value at the start of the plan – thereby offering some capital protection against a falling stock market. Your capital will be at risk if the underlying investment does fall below the defined level, in which case your initial capital will be reduced by 1% for each 1% fall and so you could lose some or all of your initial investment.
Investment funds
Investment funds are another way of gaining access to the potential for higher income than available from cash. You can choose the frequency of any payment, with many bond funds offering monthly income whilst equity funds normally pay quarterly.
In the UK equity sector, Schroder’s Income Maximiser fund aims to deliver a target yield of 7% per year whilst in the fixed interest sector Royal London’s Corporate Bond fund has a current distribution yield of 5.29% with quarterly income payments and Threadneedle’s High Yield Bond fund has a current distribution yield of 6.60% and pays income monthly. Always remember that these yields are not guaranteed and subject to fluctuations.
Investment funds and your capital
In addition, the treatment of your capital is different to the previous two options covered – there is certainly no capital protection offered, nor is there the conditional capital protection associated with fixed term investment plans.
This is important since the income yield and any rise or fall to your original capital should always be considered together since both have an effect on your overall return. For example a 9% annual income is not as compelling if it coincides with a 9% reduction in your capital as overall you have only broken even.
Use tax free income where you can
One of the main benefits of an ISA is that income is received tax free with no further tax to pay. So particularly for income that would normally be subject to income tax (interest from deposit based savings or bond income) this can make a big difference, especially over time. With the lowest marginal rate of income tax currently standing at 20%, this is a sizeable reduction to any stated returns on offer.
The deposit plans we offer are available as a Cash ISA and the investment plans and funds are available as an Investment ISA whilst all accept ISA transfers (prior to 1st July deposit based ISA plans will not be able to accept transfers from Investment ISAs). Remember that tax treatment of ISAs depends on your individual circumstances and may be subject to change in the future.
Finally, be vigilant and do your homework…
For those looking for income it has perhaps never been more important to manage your savings and investments carefully, remaining vigilant and not allowing inertia to reward the banks as they drop the savings rates they are paying, or the investment managers whose funds continue to underperform.
Not only must we ask ourselves what we are buying when committing to a product designed to provide us with an income, we should also be considering what alternatives are available since unfortunately the current economic climate can lead us to a tough decision – either lose money in real terms from a savings account, or take on more risk.
This month’s Top 3 income investments
These are the Top 3 most requested income investments by our customers this month:
1. Up to 6% income, quarterly payments: Start Point Quarterly Income Plan »
2. 5.52% fixed income, monthly payments: Investec Enhanced Income Plan »
3. Up to 9.04% income, quarterly payments: Focus FTSE 4 Quarterly Income Plan »
Compare capital protected income plans »
Compare income investment plans »
* Investment Week, 12/05/2014
** the Distribution yield reflects the amounts that may be expected to be distributed over the next twelve months as a percentage of the Fund’s net asset value per share as at the date shown. It is based on a snapshot of the portfolio on that day. It does not include any initial charge and investors may be subject to tax on distributions. All fund data correct as at 28/02/2014
No news, feature article or comment should be seen as a personal recommendation to invest. Prior to making any decision to invest, you should ensure that you are familiar with the risks associated with a particular investment. Different types of investment carry different levels of risk and may not be suitable for all investors. The value of investments and income from them can fall as well as rise and you may not get back the full amount invested. If you are at all unsure of the suitability of a particular investment, both in respect of its objectives and its risk profile, you should seek independent financial advice.
Tax treatment of ISAs depends on your individual circumstances and is based on current law which may be subject to change in the future. Always remember to check whether any charges apply before transferring or switching an ISA.
Structured deposit plans are capital protected. There is a risk that the company backing the plan or any company associated with the plan may be unable to repay your initial investment and any returns stated. In this event you may be entitled to compensation from the Financial Services Compensation Scheme (FSCS), depending on your individual circumstances. In addition, you may not get back the full amount of your initial investment if the plan is not held for the full term. The past performance of the FTSE 100 Index is not a guide to its future performance.
Structured investment plans are not capital protected and are not covered by the Financial Services Compensation Scheme (FSCS) for default alone. There is a risk of losing some or all of your initial investment. There is a risk that the company backing the plan or any company associated with the plan may be unable to repay your initial investment and any returns stated. In addition, you may not get back the full amount of your initial investment if the plan is not held for the full term. The past performance of the FTSE 100 Index or shares listed on the Index is not a guide to their future performance.
In addition, you may not get back the full amount of your initial investment if the plan is not held for the full term. The past performance of the FTSE 100 Index or shares listed on the Index is not a guide to their future performance.
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