Income considerations
Author: Cathy Dixon, investment director
This article previously appeared in the Irish News in October 2011
Last week we saw inflation figures released which yet again were considerably above the official target. The government target of 2% for the consumer price index has not been achieved since November 2009 – almost two years ago – and has exceeded 4% throughout 2011, it now stands at 5.2%. Few of us need informing that it is harder to make ends meet now, with higher food and fuel prices and wages just not keeping up. In addition many people have seen the value of their house plummet and the level of unemployment is on the rise (currently at a 17 year high). Not a rosy picture and one that has prompted discussion about the fact that despite the UK officially exiting recession almost two years ago, it is now that households are really feeling the pinch.
It is a particularly difficult time for savers. Previously the safest investment of all – cash – would have provided safety combined with a rate of return that was unexciting but acceptable. Now with interest rates at such a low level: base rates have been at 0.5% for well over two years (March 2009), the rate of return on cash has failed miserably to keep up with inflation. In technical terms, the real rate of interest on cash has been negative for some time (interest rate minus the rate of inflation). There is unfortunately no easy solution to this dilemma. The bottom line is that to increase income from savings also means increasing the level of risk. Going one step up the risk ladder is a little help: government bonds (gilts) offer a slightly better rate of return than cash, but are also standing at historically low levels of interest as investors have piled in over the past several months as they appeared to offer a safe haven in the midst of market turbulence. The one problem with this is that most gilts are standing at a price well above the level at which they will ultimately be redeemed, hence there is an in-built capital loss.
Moving further up the risk spectrum we get to corporate debt. This involves buying bonds issued by companies which are looking for funds. The returns are certainly better here, but it is often difficult to deal in individual corporate bonds, as many have high minimum transaction sizes and there is the risk of default. Unsurprisingly, the bigger the risk, the higher the rate of interest. One good alternative is a corporate bond fund which offers the chance to invest in a wide range of corporate bonds as selected by the fund manager. Another few steps up the risk spectrum brings us to equities. Here there is the chance of growing income as well as the possibility of capital growth. Currently there are 25 stocks in the FTSE 100 index with prospective dividend yields of over 5%, including such well known names as Vodafone, Marks & Spencer and National Grid. There are also several collectives (investment trusts or open ended funds) which also offer good returns, well in excess of the return on cash.
Clearly there is a trade-off here: income and risk, which is a very personal choice. These are extraordinary times, however, which might merit different choices.
For further information, please contact:
Cathy Dixon
Director
Investment management
T: 028 9072 3000
This does not constitute a recommendation to buy or sell investments and the value of any shares may fall as well as rise. Investments carry risk and investors may not receive back the amount invested. The views expressed are those of the author and not necessarily of Cunningham Coates Stockbrokers.
Cunningham Coates Stockbrokers is a trading name of Smith & Williamson Investment Management Limited. Authorised and regulated by the Financial Services Authority. Registered number 131816.