Demand for growth and income an opportunity for advisers

The acute need for both capital growth and reliable income may worry retail investors – especially in and around retirement – but represents an opportunity to add value to an investment plan for knowledgeable advisers.

The assessment comes from Imara Asset Management, South Africa, a Johannesburg-based wealth management and financial planning firm that is consulted by many salary-earners targeting long-term capital growth and thinking about retirement income.

Managing director Lara Warburton has warned in the past about the wealth-depleting effects of ‘taxflation’ – inflation that erodes the value of savings and the impact of taxes on income derived from risk-shy portfolios that are underweight in equities.

Recent events heighten this challenge.

She notes: “Clients are risk averse following the financial crisis. Simultaneously, they see the increase in dividend tax with the introduction of dividends withholding tax and the possible impact on income-generating hybrids like preference shares and therefore become more sensitive to taxation effects.

“In this situation, well-qualified advisers can add considerable value by explaining the characteristics of various financial products while putting them into the context of a low interest rate environment in which inflation remains moderately high and taxation effects can be quite onerous.”

Tax effects on another hybrid –property – also warrants discussion with income-seeking clients.

Longer term issues such as longevity and planning for perhaps 35 years in retirement also demand attention as these factors may affect risk tolerance and indicate continued commitments to equities and equity unit trusts – the asset class with the best long-term record for inflation-beating returns.

The good news from Imara is that capital growth can be combined with income creation when good equity returns are achieved year after year. For example, the Imara Equity Fund had an annual compound return of 25.3% over the three years to the end of April 2012.

Warburton explains: “With collective investments, income can be provided out of a portion of a portfolio’s capital growth through the regular sale of units, especially if the income is 5% per annum or less.

“You achieve long-term capital appreciation when the income draw is less than the annual growth on the investment.

“This is often a tax effective way of providing income for investors in higher tax brackets.”

Extensive experience with middle income and high income earners indicates that many clients like to receive regular income from their investments, even though they may not need it. They then look to re-invest the cash that builds up.

“This is illogical,” says Warburton, “because they often pay fees to invest, to earn an income that is taxed and then pay fees again to re-invest.

“It is best to only draw an income the client really needs.”