Seeking Income in a Low Interest Rate Environment

How do you Find Income in an Environment of Historically low Interest Rates and Negative Inflation?

Dr Stephen Barber Considers one Possibility. 

As inflation in Britain falls to an all-time low, the long anticipated rise in interest rates remains as elusive as ever meaning those seeking income, from savings or bonds, are still having a tough time.  It’s an issue across asset classes so could the solution be found in using capital as income?

It has been a dry spell for those reliant on income.  The very loose monetary environment has stripped returns from cash and fixed income products forcing some investors to look to the higher risk stock markets to meet their targets.

While there has been some relief over the past year or two, the financial crisis saw widespread cuts in dividends announced by London quoted firms.  Many of us looked overseas.

But today there’s a further environmental problem in equities for income seekers who simply cannot escape these unusual economic conditions.

The strength of the dollar combined with the collapse in the price of oil price means that dividend growth is likely to be much slower in 2015.  The United States led the trend in 2014 which actually proved to be a record year for dividend growth.

‘It has been a dry spell for those reliant on income. The very loose monetary environment has stripped returns from cash and fixed income products forcing some investors to look to the higher risk stock markets to meet their targets’

But according to Henderson Global Investors, the headline rate will now fall from more than 10% last year to just 1% this.

That doesn’t mean dividends are elusive but stronger stock markets inevitably means lower yields.

That of course is an important distinction.  For those already holding an asset, rises or falls in the share or fund price will mean a fall or rise in the percentage income yield but the actual payout per unit will not change unless the company or manager changes policy.

For those seeking a longer term income, reliability is the key.

Big, global, defensive sectors such as pharmaceuticals or consumer durables tend to display slower, less volatile, growth but also enjoy steady revenues.

For this type of investing, volatility can be helpful as it offers opportunities to buy on general market dips, thereby locking in yields but it does need some attention.

There is another way to secure an income that requires a bit of lateral thinking.

Split Capital Investment Companies offer different classes of share and in their simplest form ‘split’ into income and capital growth.  Now that is all well and good and investors might be able to locate some income.

But there is another class called Zero Dividend Preference Shares (Zeros) which have a limited life and pay back predetermined capital sums as the company is wound up at pre-set dates.

By investing in a portfolio of Zeros it is possible to plan a series of regular payments over a given period.  Sure they are technically paying capital but does that matter?

‘By investing in a portfolio of Zeros it is possible to plan a series of regular payments over a given period. Sure they are technically paying capital but does that matter?’

Well, it means there’s no income tax to pay.

And remember too that every year HMRC gives us £11,000 Capital Gains Tax Allowance which means we can profit up to that level without liability.

A large number of investors make little use of this allowance which means it is lost come April.  But if it is used to deliver a regular payment, it means that a capital profit can be treated as an income and be tax efficient.

Take care with these products though, they can be complex and different classes of shares carry with them different levels of risk.

A scandal some years ago exposed poor management so it pays to be choosy; though it has meant a smaller investment universe.  Always take advice if you are unsure.