Income Investing - ABC radio material
In really volatile times like these, investors often don't think about the income that their investments are paying to them.
Whether it be property, shares, cash of fixed interest, they often focus too much on the price of the investments.
However income can be a great investment benefit, and is actually more important in some ways to investors.
When you invest in shares, you invest in a company or portfolio of companies. Every year these companies earn some money. They keep some of this to re-invest in new projects, and the rest they pay to investors as dividends, usually twice a year. Investors often forget about this.
John Burr Williams was a famous investment author, and wrote a book in the 1930's on investment analysis. He had this poem about investing, reminding of the importance of income (dividends):
"A cow for her milk,
a hen for her eggs,
And a stock, by heck,
For her dividends.
An orchard for fruit,
Bees for their honey,
And stocks, besides,
For their dividends."
At the moment various asset classes are paying income of:
Cash - at least 7%
Fixed interest - at least 7.5%
Listed Property trusts - at least 7.5% a year (and will grow over time)
Australian shares - 4.5% a year, plus a tax benefit of 1.75%; total of 6.25% (and will grow over time)
Direct Residential Property - commentary this week about the strong increases in rents paid from investment properties (also will grow over time)
The important point is that income is more reliable than the price of investments:
1/ Shares have fallen in price by about 25% since the market top - there is absolutely no suggestion that the income (dividends) will fall by anywhere this amount - if at all. Certainly the forecast is for 'slowing earnings growth', but not negative growth at this stage. For example, St George and Woolworths have both indicated that their earnings growth will be around 8% - not too bad really.
2/ Income from growth assets counter the impact of inflation, because they provide growing income streams.
Using Income in Planning a Portfolio
Let's consider a case study of a couple retiring at age 60. If they have $200,000 then they might want to work out a portfolio that they can draw income from at a rate of $10,000 a year, to supplement the age pension of around $25,000 that they will receive.
What they might do is invest $40,000 in cash and fixed interest investments. In this way they will have 4 years of income set aside so even if share and property investments are volatile - like now - they not have to worry as much.
So they invest the rest in growth assets, including Australian shares, listed property and global shares.
The table below shows the expected income:
If they were paying reasonably moderate fees of 1.25%, their fees would be $2,500. So after fees there would be $9,275 in income to pay their $10,000 of living costs - so they dip into just $775 worth of cash.
Also - the income from the shares and property would be expected to increase over time, which is pretty powerful.
In this way you don't have to worry too much about market volatility - so long as the investments are paying a reasonable income stream and there is enough cash set aside you can be relaxed about how your portfolio will meet your retirement income needs.