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Investing for Income in 2012

Fri, 08 Jun 2012 15:18:31 GMT

Investing for Income in the Current Economic Climate

Investors with an immediate requirement for income are seeking alternatives to traditional financial market investments. As low interest rates combine with high inflation, volatile financial markets and economic uncertainty on a global scale, Investors and Financial Planners are reducing their exposure to equity markets in seeking out alternative assets capable of replacing lost investment income. Here we look at the importance of income generating assets as part of a diversified portfolio.

The importance investing for income

Investments that generate income are a fundamental pillar of successful asset allocation and portfolio planning. As income can be immediately re-invested, this allows Investors to expand the size of their portfolios and compound annual returns, especially over extended timelines, leading to higher performance and lower risk.

The 2011 Barclays Equity Gilt Study gives an interesting example; an investment of just £100 made at the end of the Second World War would be worth only £5,721 today, without adjusting for inflation. However, if the income received throughout the term of the investment has been re-invested, that £100 would have been worth a phenomenal £92,460 by the end of 2008. This clearly demonstrates the importance of holding income investments within a portfolio. Furthermore, income can be re-invested in other assets, adding further risk-reduction through on-going diversification.

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How much income do I need from my investments

When taking into account taxes and inflation, the income required in order to generate a ‘real’ return i.e. a return after taking off tax and adjusting for inflation, might be considerably higher than one might imagine, or indeed be able to access.

Assuming then higher rate of UK tax at 40%, and inflation at 3% (April 2012), a cash deposit account with a yield of 3.6% will generate a financial loss – in real terms – of 0.9%. In fact, an investment generating an income yield of 10% will result in a net gain after tax an inflation of just 2.82%.

So, an investor with investable assets of £250,000 achieving a consistent gross income of 10% per annum will generate a NET annual income - after putting some of the income back into the pot in order to offset inflation – of just £12,500 assuming a basic tax rate of 20%. The same portfolio yielding 5% will generate a NET annual income after deductions for tax and inflation of only £2,500, or 1%. So Investors looking to grow the value of their portfolio – or generate a Net annual income – of 5% must earn at least 10% from their investments.

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Where to find high-yield income investing opportunities in 2012

The current climate, defined in no short measure by, poor returns on cash, volatility and uncertainty, has created an aversion to traditional income investing tools such as stocks, bonds and cash. Instead, Investors and Financial Planners are looking further afield and seeking out physical, tangible assets that share a much lower correlation with financial markets.

On such area of interest – especially for the income investor – is real estate, and current market conditions have created somewhat of a ‘perfect storm’ in some markets where property assets can be acquired with such deep discounts as to significantly enhance yields. Whilst not without inherent risks including potential illiquidity, on-going costs for taxes and maintenance, and requirement to manage tenants, such opportunities exist delivering annual yields of more than 15%. Or for the Investor seeking to take short term profits through buying at a discount and selling very quickly at market value, capital profits of 20% per transaction are not uncommon, however there may be resale or asset-specific issues which might impact the performance of such an investment strategy. Investors are advised to take professional advice, both from a real estate professional with a track record of delivering successful opportunities, and from a duly regulated and authorised financial advisor who may be able to advice on the individual suitability of any investment.

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