Safeguarding your money at a time of low interest rates
How do you generate a reliable income when interest rates are stuck at all-time lows and the Bank of Englands quantitative easing policy of printing money is squeezing yields on government bonds (gilts) and other investments? Investors today can still rely on a well-balanced portfolio to meet their needs for income. However, they must be open-minded about the sources of that income, and recognise that low-risk income generation is a thing of the past.
Mark Carney, the new Governor of the Bank of England, has inaugurated a policymaking revolution by announcing that the central bank will hold interest rates at their present record low level of 0.5 per cent until the national unemployment rate falls to at least 7 per cent. Under its latest economic forecasts the Bank does not expect this target to be hit until the second half of 2016, implying that the cost of borrowing throughout the economy will remain low for three more years.
If you are an income-seeker, much will come down to your attitude to risk for return. If you want no or very low risk, you may wish to consider a traditional cash bank account and accept that income levels are likely to remain low for the foreseeable future. However, if youíre further up the risk scale you may wish to opt for some of these other alternatives.
If youíre willing to take on a slightly higher degree of risk and you need the extra income, you may wish to consider gilts (or gilt-edged stocks), which are bonds issued by the Government and pay a fixed rate of interest twice a year. Gilts involve more risk than cash, because thereís a chance the Government wonít be able to pay you back. Itís highly unusual for a government to default on a debt or default on the interest payments, so they have been considered safe. But in this current economic climate, this risk increases.
You are not guaranteed to get all your capital back under all circumstances. Not all gilts are bought from the Government and held to maturity; some are bought and sold along the way, so thereís a chance for their value, and the value of gilt funds, to rise and fall. There are other types, such as index-linked gilts, which form the largest part of the gilt portfolio after conventional gilts. Here the coupon is related to movements in the Retail Prices Index (RPI) and is linked to inflation.
Next along the risk scale if you are looking for a higher yield are corporate bonds. These are issued by companies and have features that are exactly the same as gilts except that, instead of lending money to the Government, youíre lending to a company. The risk lies in the fact that companies may go bust and the debt may not be repaid. They have a nominal value (usually £100), which is the amount that will be returned to the investor on a stated future date (the redemption date). They also pay a stated interest rate each year, usually fixed. The value of the bonds themselves can rise and fall; however, the fact that bonds are riskier at the moment means companies are paying more in order to induce people to buy their debt. There are an increasing number of global bond funds entering the market that may enable you to get value from a lot of different markets.
If your primary objective is the preservation of income, you may not consider the stock market as the obvious place for your money. However, for investors who are prepared to see their investments fluctuate in value while hopefully providing a stable income that grows over time, you may wish to consider equity income funds. These invest in shares, focusing on the big blue-chip firms that have a track record of good dividend payments. The dividends will be your income.
Global equity income funds
Further up the risk scale are global equity income funds. These are similar to UK funds, except that there are only a handful of the big blue-chip firms that pay reliable dividends in the UK, whereas global diversification offers a significant range of companies to choose from. Investing in other currencies brings an added level of risk, unless the fund hedges the currency.
Equity income investment trusts
Equity income investment trusts are higher risk but similar to other equity income investments. They are structured differently from unit trusts and open-ended investment companies. Investment trusts are closed-ended. They are structured as companies with a limited number of shares. The share price of the fund moves up and down depending on the level of demand, so the price of the trust depends not only on the value of the underlying investments but also on the popularity of the trust itself. In difficult times, when investors are selling up, trusts are likely to see their share price fall more than the value of their underlying investments. This means they also have more potential for greater returns once better times resume. Investment trust share prices are therefore often at a discount or premium to the value of the assets in the fund.