“Income only” misses the point when it comes to generating income

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What is the best way to invest your funds, when you are targeting “income”?

Conventionally many investors would pick assets that provide a good income (yield) but it could be equally valid to pick assets that increase in value (growth) and take some of the profits as you go.

With new pension freedoms, the way you manage your pension fund “at retirement” and “in retirement” could have changed drastically. You may decide not to buy an annuity to give you a secure income for life. Instead, you may decide to take control of your pension, as well as the strategy for providing for your income needs. If you are looking at your current or future income, you have some important questions to answer here.

  • How long will you need this income for?
  • Will the amount you need change in the future?
  • What is the best way to achieve your target?

Your pension now becomes a “wrapper” that sits around a basket of assets. So what you decide to keep in your basket becomes very important when you try to target an income.

Income can come in a few different forms. It could come from dividends from shares (potential profits paid out by companies), interest from “fixed interest” assets like government bonds but you could also achieve the same effect through capital withdrawals; by selling something to give you a lump sum to call upon in stages (capital gain).

An “income strategy” could involve picking a fund that works largely in UK companies, these companies could have a good record of paying regular dividends over a longer term, for example. Another strategy could be to look at assets that may not pay as much in the way of income, but have a potential to increase in value over time to be sold.

Things to consider

If you are leaning towards either of these strategies, you could be missing the point. The corner stone of planning for the future, is to consider the end goal and work backwards. If the goal is to produce regular income to cover expenses, what this income is made up of should not really matter. Within a Pension or ISA wrapper Capital Gains are tax free, so realising the gains on your basket of assets becomes a great way to provide a regular “income” (though technically it is provided by capital withdrawals).

Building a structured financial plan that considers all of your assets within the portfolio as potential sources of income is vital. A comprehensive personal financial plan allows you to discuss what your needs are each year and then build a total return from the most appropriate underlying assets.

By focusing on only income assets to achieve your goal, you are running three main risks.

  1. You are narrowing your investments field and denying yourself the opportunity to diversify investment volatility
  2. You ignore the ability to utilised capital growth across your assets. In recent years capital growth has been positive when discussed alongside dividend and income yields.
  3. You potentially reduce the flexibility needed to help achieve your goals.

By building a flexible, “total return” strategy to meet your needs, makes the best of both approaches.

Making sure you build a personal financial plan, means that when you need to take income, you have the opportunity to call upon all aspects of investment performance and not just the income your basket is paying at that time.

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26 Jan 2024

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