Rather than rely solely on term deposits, a more diversified approach is having a cash reserve and investing the rest in a portfolio of dividend-paying shares.
With the interest rate reality that investors face in the foreseeable future – one of continuing low rates – the key question you need to ask is how much capital security you want from your investments.
Do you want a decent income flow where you are not worried about changes in the capital value of your investments, or is absolute capital security your most important consideration?
If there is one category of investments that offers instant diversification, it is exchange traded funds.
If the latter is your priority, then unfortunately with the latest reduction in the official cash rate to 1.25 per cent, bank deposits paying less than 1 per cent and term deposits paying below 2 per cent will increasingly be the best you can get. For many, this will be a dismal prospect.
But if you can tolerate fluctuations in the capital value of your assets, identifying investments that offer income such as share dividends that can pay income of 4 to 5 per cent and distributions from managed funds, including exchange traded funds (ETFs), are available alternatives.
Further, many of these investments since the federal election continue to be enhanced with dividend imputation franking credits that pay cash refunds to investors on marginal tax rates below 30 per cent. Investors most relieved by this are self-managed superannuation funds that pay investment tax-exempt pensions.
As AMP Capital’s head of strategy, Shane Oliver - a veteran financial markets follower - shared with me: “History tells us that in Australia if you have a portfolio of diversified companies that pay reasonable dividends, that income flow should be relatively stable.”
The challenge is to identify such a portfolio and the only way to do so is to become a more active investor. That said, any strategic move should be approached in a calm and disciplined way. After all, deciding to allocate a majority proportion of your funds – as high as 70 to 80 per cent – to shares and income-paying managed funds, with the balance in cash and term deposits, might come across as a radical idea.
One suggestion for retirees that has been around for quite a while is having a no-risk cash and term deposit pool equal to three or four years of income needs. This is supported by a second pool of medium-risk assets to cover your life expectancy and replace your income investments as they are spent.
Falling interest rates can be good and bad news for investors and this will depend on where you are invested. Although they are bad news for those in bank deposits, lower interest rates can make assets like shares and property look cheaper.
It is one of the realities of investing that anyone who is more active and has a diversified approach to investing can always cope much better in difficult times than those who rely on a single-strategy approach like being too reliant on term deposits.
Value of ETFs
As far as opportunities to become a more active investor are concerned, a focused investor can expand his or her horizons by adding ETFs to the portfolio.
If there is one category of investments that offers instant diversification, it is ETFs. It is also a category with a strong emphasis on explaining what it offers, as any visitor to the websites of prominent ETF promoters Vanguard, State Street, Blackrock, BetaShares, ETF Securities and VanEck will find.
Included among these offerings are funds with portfolios that have been deliberately designed for their diversified income potential. An example is the Vanguard Australian Shares High Yield ETF. This fund invests in 56 shares with higher forecast dividends relative to other Australian companies. Over the past three years to the end of May, its average annual performance has been 9 per cent.
By John Wasiliev - writes on Personal Finance specialising in Superannuation & SMSFs, Managed Funds, Trusts. Email Johnat firstname.lastname@example.org
14 June 2019