Where do you find yield?

For a large part of society, the capital gain on their investments is an incidental thing. For them, income is much more important. When they look at their investments, both the stability and the amount of income are key considerations in their investment decisions. While we may look at the lower interest rate environment and heave a sigh of relief, for them the lower yield they will now be receiving on their interest bearing funds is distressing.

For these people (who are often older and retired, have paid off their homes and who have a large proportion of their investments in money market accounts) the search for yield is reaching fever pitch; unfortunately it may prove to be more arduous than they expect.

The three main ways of improving or maintaining your standard of living all require you to take on slightly more risk, fortunately it should not be without its reward.

The first way is to swap into higher yielding fixed interest assets - the most common one being non-government bonds. The problem with this is that most investors do not have access to these types of bonds, nor do they have the expertise to properly manage them. The solution to this problem lies in selecting a fund manager with a stated goal of selecting bonds that fit in this category. There is however a down side.

While these bonds do currently offer a higher yield, they also carry a higher risk. The capital value of the bonds may be more volatile, however if the investor is mostly interested in income this should not be a problem. Another issue is that the institution issuing these bonds may default. While this is a distinct possibility, especially given the recent economic problems, in South Africa we have not ever had a listed bond default and our financial and banking systems are in significantly better shape than those of US and Europe.

Property is another asset class that could be considered. While the yields on properties are currently lower than those of bonds, the possibility for that income to grow is not an attribute of traditional fixed interest investments. Property is a bit of a schizophrenic asset class. At times its behavior mirrors that of bonds and at other times it behaves more in line with financial shares. It is important to remember that in a property investment, both the capital and the income could be subject to variation. Yet regardless of this fact it is often included in retirement portfolios.

A last option is equities. Equities (or shares) are not traditionally seen by investors as an income providing asset classes, yet many of the world’s richest people derive their income solely from them.

The reason traditional investors avoid equities for income is because the yield on equities is traditionally a lot lower than that seen from other asset classes. Furthermore, both the income and the capital is often subject to a lot of variation. People who are very wealthy can live with both these problems. The up side from using equities for income provision is that the income stream should be able to keep pace with inflation over the long term. Additionally, the income (dividends) from equities is currently not taxed in South Africa. (There are plans in the works to change it, but the exact details are still unknown).

Given the current market levels, it may be possible for many investors to include equities as an income-generating asset class. Other investors may simply use them to make a medium term capital gain. This will allow an investor to retain their standard of living, even if yields were to remain low for a while.

For many investors however this all seems like too much hassle. For those who feel that they should leave these decisions in the hands of fund managers, there exists an entire category of funds with the express purpose of shifting your capital between different income generating assets. Funds in the “Fixed Interest Varied Specialist” category can invest in anything from cash to bonds and property and everything in between.

While the search for yield may be daunting, you do not have to walk alone. A trusted financial advisor and a good fund manager will help you along the path.