Discipline pays off

Many investors, particularly the retired elderly who are dependent on the return from their building society deposits, have now spent several years devoid of any worthwhile level of income (interest) from their deposited funds.

This income famine has also been evident in the bond markets where yields have been increasingly depressed by consistently low interest rates. More recently George Osborne allegedly came to the rescue by announcing retirement bonds at ‘competitive rates’ and targeted directly at the over-60s. Well done George, except that the best gross yield of 4 per cent, for three-year bonds, only amounts to 3.2 per cent after 20 per cent income tax, and the maximum investment is £10,000.

The real problem for many investors and savers is that they do not wish to put their capital at risk but they do need a better return than the 1-3 per cent currently available from deposits. For if investors were prepared to approach a longer-term strategy involving equity investment, they could immediately increase their income returns quite dramatically.

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By investing in a good spread of large, sound and high-yielding shares, or by buying a small selection of high-income funds (some of which blend shares and high-yielding bonds), they can currently achieve a dividend yield of approximately 4-5 per cent.

Neil Woodford, the high-profile ex-Invesco fund manager (with a tremendous track record in achieving equity income performance over many decades), launched his own equity income fund last year. It has more than £4bn invested and has a minimum target yield of 110 per cent of the FTSE100. So a competitive target of 3.5 per cent compared with the FTSE yield of 3.2 per cent.

I know many will suggest that talk of ‘real’ investment in the same breath as interest rates from secure deposits is inappropriate, but maybe it is time for us to reconsider the whole issue of income. To most people seeking income, the desire is simply to have a reliable source of regular net cash to defray the cost of living.

Most reasonably wealthy investors tend not to have a singular approach to supporting their lifestyles. They tend to have a cushion of deposits to give them access to ready cash and to act as a buffer or float. While high interest rates on that cash ‘float’ are attractive, most do not rely on it. Alongside this ready money they run a diversified investment portfolio which they manage on a semi-active basis to achieve two practical ends. They attempt (themselves or via their adviser) to make adjustments to their investments, to take advantage of major trends while also making sure they realise regular capital gains.

Capital gains should not be underestimated in the goal of generating regular tax-efficient cash to use as ‘income’. Every individual has an annual tax-free capital gains allowance of £11,000 – a significant contribution to ‘income’ compared with the extremely modest retirement bond issue amounting to £400 per annum gross. But for those realising greater annual gains the graduated tax CGT rates are 18 per cent and 28 per cent – considerably lower than equivalent income tax rates.